Super-Exponential Endogenous Bubbles in an Equilibrium Model of Fundamentalist and Chartist Traders

Taisei Kaizoji (), Matthias Leiss, Alexander I. Saichev and Didier Sornette
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Matthias Leiss: ETH Zurich
Alexander I. Saichev: ETH Zurich and Nizhni Novgorod State University
Didier Sornette: Swiss Finance Institute and ETH Zürich

No 15-07, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We introduce a model of super-exponential financial bubbles with two assets (risky and risk-free), in which fundamentalist and chartist traders co-exist. Fundamentalists form expectations on the return and risk of a risky asset and maximize their constant relative risk aversion expected utility with respect to their allocation on the risky asset versus the risk-free asset. Chartists are subjected to social imitation and follow momentum trading. Allowing for random time-varying herding propensity, we are able to reproduce several well-known stylized facts of financial markets such as a fat-tail distribution of returns and volatility clustering. In particular, we observe transient faster-than-exponential bubble growth with approximate log-periodic behavior and give analytical arguments why this follows from our framework. The model accounts well for the behavior of traders and for the price dynamics that developed during the dotcom bubble in 1995-2000. Momentum strategies are shown to be transiently profitable, supporting these strategies as enhancing herding behavior.

Keywords: financial bubbles; faster-than-exponential growth; social imitation; momentum trading; chartists dotcom bubble (search for similar items in EconPapers)
JEL-codes: C73 G01 G17 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2015-02
New Economics Papers: this item is included in nep-upt
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Citations: View citations in EconPapers (15)

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Journal Article: Super-exponential endogenous bubbles in an equilibrium model of fundamentalist and chartist traders (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1507

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