Time-Varying Economic Dominance Through Bistable Dynamics

Xuezhong (Tony) He, Kai Li and Chuncheng Wang
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Chuncheng Wang: Harbing Institute of Technology

No 390, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: By developing a continuous-time heterogeneous agent model of multiassets traded by fundamental and momentum investors, we provide a potential mechanism in generating time-varying dominance between fundamental and nonfundamental in financial market. The deterministic skeleton of the nonlinear model tends to have bistable dynamics, characterized by a Bautin bifurcation, in which a locally stable fundamental steady state coexists with a locally stable limit cycle around the fundamental, leading to two very different market states. Market prices switch stochastically between the two persistent market states, leading to the coexistence of seemingly controversial efficient market and price momentum over different time periods. The model also generates other financial market stylized facts, such as spillover effects in both momentum and volatility, market booms, crashes, and correlation reduction due to cross-sectional momentum trading. Empirical evidence based on US market supports the main findings.

Pages: 38 pages
Date: 2018-01-01
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