Endogenous Correlation

J.-H. Steffi Yang and Steve E. Satchell

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

Abstract: We model endogenous correlation in asset returns via the role of heterogeneous expectations in investor types, and the dynamic impact of imitative learning by investors. Learning is driven by relative performance. In addition, we allow a cautious slow learning pace to reflect institutional conditions. Imitative learning shapes the market ecology that influences price formation. Using the model of non-imitative agents as a benchmark, our results show that the dynamics of imitative learning endogenously induce a significant degree of asset dependency and patterns of non-constant correlation. The asymmetric learning effect on correlation, however, implies a self-reinforcing process, where a bearish condition amplifies the effect that further exacerbates asset dependency. We conclude that imitative learning, even when rational, can to a certain extent account for the phenomena of market crashes. Our results have implications for transparency in regulation issues.

Keywords: : learning; imitation; asset correlation; market conditions (search for similar items in EconPapers)
JEL-codes: D83 G11 G12 (search for similar items in EconPapers)
Pages: 34
Date: 2003-03
New Economics Papers: this item is included in nep-cfn and nep-fmk
Note: EM (updated August 2003)
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Persistent link: https://EconPapers.repec.org/RePEc:cam:camdae:0321

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