Dynamic Analysis of a Chaotic Financial System with Reflexive Market Sentiment

Abstract

We develop a four-dimensional nonlinear model of a reflexive financial system by extending the Xin–Zhang system with a self-reinforcing sentiment channel. The model comprises four interacting variables—interest rate, investment demand, price index, and market confidence—and incorporates reflexivity to capture feedback between economic fundamentals and investor sentiment. A Lyapunov function shows that the system is well-posed and dissipative, ensuring bounded trajectories. We then analyse the dynamics using standard nonlinear-dynamics tools. Reflexive confidence sustains chaotic motion, inhibits convergence to equilibria, and produces irregular, aperiodic bifurcation patterns; sentiment-driven feedback destabilises a dissipative macroeconomic model and sustains volatility, as evidenced by a positive largest Lyapunov exponent and Kolmogorov–Sinai entropy greater than zero. Using U.S. monthly consumer sentiment and the S&P 500, we observe co-movement, a medium-horizon lead of sentiment, and a nonlinear persistence map 𝑤𝑡+1 =𝑓⁡(𝑤𝑡) —stylised facts consistent with the model’s self-reinforcing confidence channel.