Binary option market manipulation by influencing belief dynamics

Abstract

Using techniques from information geometry, we construct a semi-Hamiltonian system modelling trader beliefs in a binary asset market and study the impact of inequality or asymmetry in beliefs, information, and power on price dynamics. We show that in a market with no inequality and $N$ completely symmetric traders, the resulting dynamics evolve on a $2N+1$ dimensional manifold consisting of a $2N-2$ dimensional centre manifold, a 2 dimensional stable manifold and a 1 dimensional slow manifold. Introducing asymmetry into the traders has the potential to decrease the dimension of the centre manifold, which we prove using a parameter analysis. Using the belief model, we also study the impact of inter-agent communication, exogenous information and asymmetric purchasing power on price dynamics, showing that market bubbles can emerge when powerful traders produce outsize influence in the market, thus impacting other traders’ beliefs as well as the price. This process is exacerbated when back-channel communication is permitted. The impact of areas of high curvature in belief space is also discussed.