A Dynamic Analysis of Moving Average Rules

Carl Chiarella, Xuezhong (Tony) He () and Cars Hommes

No 05-057/1, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: The use of various moving average (MA) rules remains popular with financial market practitioners. These rules have recently become the focus of a number empirical studies, but there have been very few studies of financial market models where some agents employ technical trading rules of the type used in practice. In this paper we propose a dynamic financial market model in which demand for traded assets has both a fundamentalist and a chartist component. The chartist demand is governed by the difference between current price and a (long-run) MA. Both types of traders are boundedly rational in the sense that, based on a fitness measure such as realized capital gains, traders switch from a strategy with low fitness to the one with high fitness. We characterize the stability and bifurcation properties of the underlying deterministic model via the reaction coefficient of the fundamentalists, the extrapolation rate of the chartists and the lag length used for the MA. By increasing the intensity of choice to switching strategies, we then examine various rational routes to randomness for different MA rules. The price dynamics of the moving average rule are also examined and one of our main findings is that an increase of the window length of the MA rule can destabilize an otherwise stable system, leading to more complicated, even chaotic behaviour. The analysis of the corresponding stochastic model is able to explain various market price phenomena, including temporary bubbles, sudden market crashes, price resistance and price switching between different levels.

Keywords: Moving Averages; Fundamentalists; Trend Followers; Stability; Bifurcation; Evolutionary Switching (search for similar items in EconPapers)
JEL-codes: C60 D83 D84 E21 E32 (search for similar items in EconPapers)
Date: 2005-05-30
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
https://papers.tinbergen.nl/05057.pdf (application/pdf)

Related works:
Journal Article: A dynamic analysis of moving average rules (2006)
Working Paper: A Dynamic Analysis of Moving Average Rules (2004)
Working Paper: A Dynamical Analysis of Moving Average Rules (2004)
Working Paper: A Dynamic Analysis of Moving Average Rules (2004)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20050057

Access Statistics for this paper

More papers in Tinbergen Institute Discussion Papers from Tinbergen Institute Contact information at EDIRC.
Bibliographic data for series maintained by Tinbergen Office +31 (0)10-4088900 ().