Volatility clustering: A nonlinear theoretical approach

Xuezhong (Tony) He, Kai Li and Chuncheng Wang

Journal of Economic Behavior & Organization, 2016, vol. 130, issue C, 274-297

Abstract: This paper verifies the endogenous mechanism and economic intuition on volatility clustering using the coexistence of two locally stable attractors proposed by Gaunersdorfer et al. (2008). By considering a simple asset pricing model with two types of boundedly rational traders, fundamentalists and trend followers, and noise traders, we provide theoretical conditions on the coexistence of a locally stable steady state and a locally stable invariant circle of the underlying nonlinear deterministic financial market model and show numerically that the interaction of the coexistence of the deterministic dynamics and noise processes can endogenously generate volatility clustering and long range dependence in volatility observed in financial markets. Economically, volatility clustering occurs when neither the fundamental nor trend following traders dominate the market and when traders switch more often between the two strategies.

Keywords: Volatility clustering; Fundamentalists and trend followers; Bounded rationality; Stability; Coexisting attractors (search for similar items in EconPapers)
JEL-codes: D84 E32 G12 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (15)

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Working Paper: Volatility Clustering: A Nonlinear Theoretical Approach (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:130:y:2016:i:c:p:274-297

DOI: 10.1016/j.jebo.2016.07.020

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