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A prototype model of speculative dynamics with position-based trading

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  • Franke, Reiner
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    Abstract

    The paper extracts a prototype asset pricing model from the literature where a market maker adjusts prices in response to order imbalances and the strategies of fundamentalists and chartists are position-based, that is, the two groups are specified in terms of their desired holdings. The deterministic formulation of the model leads to a neutral delay-differential equation of the price, whose mathematical analysis is non-standard and may be of independent interest. The stability conditions are nevertheless quite analogous to the order-based Beja-Goldman model. The effects of parameter variations are also studied in a stochastic setting, where special emphasis is put on the misalignment between price and the time-varying fundamental value, the market maker's risk aversion, and the differential profits of fundamentalists and chartists.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

    Volume (Year): 33 (2009)
    Issue (Month): 5 (May)
    Pages: 1134-1158

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    Handle: RePEc:eee:dyncon:v:33:y:2009:i:5:p:1134-1158

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    Web page: http://www.elsevier.com/locate/jedc

    Related research

    Keywords: Asset pricing Market maker risk aversion Misalignment Neutral delay-differential equation;

    References

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    1. Chiarella, Carl & Dieci, Roberto & Gardini, Laura, 2006. "Asset price and wealth dynamics in a financial market with heterogeneous agents," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1755-1786.
    2. J. Doyne Farmer & Shareen Joshi, 2000. "The Price Dynamics of Common Trading Strategies," Working Papers 00-12-069, Santa Fe Institute.
    3. Rui Carvalho, 2001. "The Dynamics of the Linear Random Farmer Model," Papers cond-mat/0107150, arXiv.org.
    4. Reiner Franke & Toichiro Asada, 2008. "Incorporating positions into asset pricing models with order-based strategies," Journal of Economic Interaction and Coordination, Springer, vol. 3(2), pages 201-227, December.
    5. Beja, Avraham & Goldman, M Barry, 1980. " On the Dynamic Behavior of Prices in Disequilibrium," Journal of Finance, American Finance Association, vol. 35(2), pages 235-48, May.
    6. Frank Westerhoff, 2003. "Market-maker, inventory control and foreign exchange dynamics," Quantitative Finance, Taylor & Francis Journals, vol. 3(5), pages 363-369.
    7. Bradfield, James, 1979. "A Formal Dynamic Model of Market Making," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 14(02), pages 275-291, June.
    8. He, Xue-Zhong & Li, Youwei, 2007. "Power-law behaviour, heterogeneity, and trend chasing," Journal of Economic Dynamics and Control, Elsevier, vol. 31(10), pages 3396-3426, October.
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    Cited by:
    1. Fabio Tramontana & Laura Gardini & Frank Westerhoff, 2011. "Heterogeneous Speculators and Asset Price Dynamics: Further Results from a One-Dimensional Discontinuous Piecewise-Linear Map," Computational Economics, Society for Computational Economics, vol. 38(3), pages 329-347, October.
    2. Dieci, Roberto & Westerhoff, Frank, 2010. "Heterogeneous speculators, endogenous fluctuations and interacting markets: A model of stock prices and exchange rates," Journal of Economic Dynamics and Control, Elsevier, vol. 34(4), pages 743-764, April.

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