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Heterogeneous beliefs and adaptive behaviour in a continuous-time asset price model

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  • He, Xue-Zhong
  • Li, Kai
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    Abstract

    This paper extends the analysis of the seminal work of Brock and Hommes (1997, 1998) on heterogeneous beliefs and rational routes to randomness in discrete-time models to a continuous-time model of asset pricing. The resulting model characterised mathematically by a system of stochastic delay differential equations provides a unified approach to deal with adaptive behaviour of heterogeneous agents and market stability impact of lagged price used by chartists to form their expectations. For the underlying deterministic model, we show not only that the result of Brock and Hommes on rational routes to market instability in discrete-time holds in continuous-time but also a double edged effect of an increase in lagged price used by the chartists on market stability. For the stochastic model, we demonstrate that the interaction and boundedly rational behaviour of heterogeneous agents can generate various market phenomena such as bubbles and crashes and replicate stylised facts including volatility clustering, and long range dependence in volatility.

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    Bibliographic Info

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

    Volume (Year): 36 (2012)
    Issue (Month): 7 ()
    Pages: 973-987

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    Handle: RePEc:eee:dyncon:v:36:y:2012:i:7:p:973-987

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

    Related research

    Keywords: Heterogeneous beliefs; Bounded rationality; Adaptiveness; Fundamentalists; Chartists; Stability; Stochastic delay differential equations;

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    References

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    3. Carl Chiarella & Xue-Zhong He, 1999. "Heterogeneous Beliefs, Risks and Learning in a Simple Asset Pricing Model," Research Paper Series 18, Quantitative Finance Research Centre, University of Technology, Sydney.
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    Citations

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    Cited by:
    1. Sandrine Jacob Leal, 2013. "Momentum effect in individual stocks and heterogeneous beliefs among fundamentalists," Economics Bulletin, AccessEcon, vol. 33(4), pages 3102-3116.
    2. Corrado Di Guilmi & Xue-Zhong He & Kai Li, 2013. "Herding, Trend Chasing and Market Volatility," Research Paper Series 337, Quantitative Finance Research Centre, University of Technology, Sydney.
    3. Xue-Zhong He & Kai Li, 2014. "Time Series Momentum and Market Stability," Research Paper Series 341, Quantitative Finance Research Centre, University of Technology, Sydney.

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