Financial markets with heterogeneous agents as nonlinear news filters

Cees Diks ()

No 290, Computing in Economics and Finance 2005 from Society for Computational Economics

Abstract: This paper aims at increasing our insights into the way financial markets respond to news. We view the market as a (nonlinear) filter of news on fundamentals. A stylized version of this situation is obtained by considering by a time dependent dividend rate which is driving the market. To model this, we take as a starting point a market model of the CBS (Continuous Beliefs Dynamics) type developed by Diks and Van der Weide (2003). The model is adapted in such a way that the dividend rate is no longer required to be constant, but, for example, might follow a geometric Brownian motion. Already for model parameters for which the price tends to a stable equilibrium price under a constant dividend rate, this modification leads to complicated stochastic dynamics. Simulations show that the price responses to shocks on the dividend rate can become highly nonlinear and persistent, as a result of triggering the endogenous noise process of the CBS. In a simulation study we found that this type of nonlinear response to news can generate many typical properties of asset prices, such as volatility clustering, fat-tailed return distributions, and persistence of deviations from fundamental prices.

Keywords: Heterogeneous agents; Financial markets; Continuous BeliefsSystems; Nonlinear Response; News Induced Endogenous Noise (search for similar items in EconPapers)
JEL-codes: C00 D84 G12 (search for similar items in EconPapers)
Date: 2005-11-11
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Persistent link: https://EconPapers.repec.org/RePEc:sce:scecf5:290

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