Microfounding GARCH Models and Beyond: A Kyle-inspired Model with Adaptive Agents

Michele Vodret, Iacopo Mastromatteo, Bence Tóth and Michael Benzaquen ()
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Michael Benzaquen: LadHyX - Laboratoire d'hydrodynamique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris - CNRS - Centre National de la Recherche Scientifique

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Abstract: We relax the strong rationality assumption for the agents in the paradigmatic Kyle model of price formation, thereby reconciling the framework of asymmetrically informed traders with the Adaptive Market Hypothesis, where agents use inductive rather than deductive reasoning. Building on these ideas, we propose a stylised model able to account parsimoniously for a rich phenomenology, ranging from excess volatility to volatility clustering. While characterising the excess-volatility dynamics, we provide a microfoundation for GARCH models. Volatility clustering is shown to be related to the self-excited dynamics induced by traders' behaviour, and does not rely on clustered fundamental innovations. Finally, we propose an extension to account for the fragile dynamics exhibited by real markets during flash crashes.

Keywords: adaptive agents; volatility clustering; excess volatility; price impact (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-mst
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Published in Journal of Economic Interaction and Coordination, 2023, 18, pp.599

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