A Robust Rational Route to in a Simple Asset Pricing Model

Cars Hommes, H. Huang and D. Wang ()
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D. Wang: Peking University

No 02-08, CeNDEF Working Papers from Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance

Abstract: We investigate asset pricing dynamics in an adaptive evolutionary asset pricing model with fundamentalists, trend followers and a market maker. Agents can choose between a fundamentalist strategy at positive information cost or choose a trend following strategy for free. Price adjustment is proportional to the excess demand in the asset market. Agents asynchronously update their strategy according to realized net profits in the recent past. As agents become more sensitive to differences in strategy performance, the fundamental steady state becomes unstable and multiple steady states may arise. As the traders' sensitivity to differences in fitness increases, a bifurcation route to chaos sets in due to homoclinic bifurcations of stable and unstable manifolds of the fundamental steady state.

Date: 2002
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