Asset Pricing, Volatility and Market Behaviour: A Market Fraction Approach

Xuezhong (Tony) He (tonyxhe@gmail.com)

No 95, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: Motivated by recent development in structural agent models on asset pricing, explanation power and calibration issue of those models, this paper presents a simple market fraction model of two types of traders - fundamentalists and trend followers - under a market maker scenario. It is found that asset prices, wealth dynamics and market behaviour are characterised by the dynamics of the underlying deterministic system. The model is able to explain various market behaviour, and generate some of the stylized facts. By introducing two measures on wealth dynamics, we are able to show the limitations of profitability and rationality of different trading strategies. Six significant autocorrelation coefficients (ACs) patterns are charaterized by different types of bifurcation of the underlying deterministic system. In particular, an oscillating and decaying AC pattern with positive ACs for even lags and negative for odd lags can only be generated when the market is dominated by the fundamentalists (that is when the parameters are near the flip bifurcation boundary), and a positive decaying AC pattern with long memory can only be generated when the market is dominated by the trend followers with high decay memory (that is when the parameters are near the Hopf bifurcation boundary). The results show a promising power of stability analysis and bifurcation theory in explaining and calibrating asset price and wealth dynamics, markt behaviour, and generating various econometric properties of financial data.

Pages: 57 pages
Date: 2003-06-01
New Economics Papers: this item is included in nep-fin and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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