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Time-varying, heterogeneous risk aversion and dynamics of asset prices among boundedly rational agents

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  • Park, Beum-Jo

Abstract

Besides the heterogeneity of agents’ beliefs, we perceive that, contrary to the constant short-term risk attitude of fundamentalists, the risk attitude for chartists varies over time due to psychological factors such as prospect theory’s reflection effect, which refers to the reversing of risk aversion/risk loving in the case of gains/losses. Thus, this paper assumes that complicated dynamics in recent asset markets are attributed to the significant effects of time-varying and heterogeneous risk attitudes as well as agents’ herd behavior, and generalizes an adaptive beliefs system in order to characterize them. This paper also analyzes the existence of stable steady states of the generalized adaptive beliefs system, providing a new psychological insight into excessive and asymmetric volatility. Given the dynamic system, numerical simulations find that, when the chartists are less risk averse than the fundamentalists and their herding propensity increases, time variation in risk attitudes gives rise to large amplitude changes in proportion to agent groups and expand price fluctuations through chaotic dynamics. Along these lines, this paper highlights that psychological factors serve as decisive source of asymmetry in volatility as well as excess volatility, which are observed in the return data.

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  • Park, Beum-Jo, 2014. "Time-varying, heterogeneous risk aversion and dynamics of asset prices among boundedly rational agents," Journal of Banking & Finance, Elsevier, vol. 43(C), pages 150-159.
    • Handle: RePEc:eee:jbfina:v:43:y:2014:i:c:p:150-159
    DOI: 10.1016/j.jbankfin.2014.03.009
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    2. Thomas Gomez & Giulia Piccillo, 2019. "Diverse Risk Preferences and Heterogeneous Expectations in an Asset Pricing Model," CESifo Working Paper Series 8003, CESifo.
    3. Park, Beum-Jo & Kim, Myung-Joong, 2017. "A Dynamic Measure of Intentional Herd Behavior in Financial Markets," MPRA Paper 82025, University Library of Munich, Germany.
    4. Xu, Xin & Xu, Xiaoguang, 2023. "Monetary policy transmission modeling and policy responses," The North American Journal of Economics and Finance, Elsevier, vol. 64(C).
    5. He, Xue-Zhong & Li, Kai, 2015. "Profitability of time series momentum," Journal of Banking & Finance, Elsevier, vol. 53(C), pages 140-157.
    6. Guillaume Coqueret, 2017. "Empirical properties of a heterogeneous agent model in large dimensions," Post-Print hal-02000726, HAL.
    7. Coqueret, Guillaume, 2017. "Empirical properties of a heterogeneous agent model in large dimensions," Journal of Economic Dynamics and Control, Elsevier, vol. 77(C), pages 180-201.
    8. Zhang, Qian & Li, Zeguang, 2021. "Time-varying risk attitude and the foreign exchange market behavior," Research in International Business and Finance, Elsevier, vol. 57(C).
    9. Michele Berardi, 2016. "Endogenous time-varying risk aversion and asset returns," Journal of Evolutionary Economics, Springer, vol. 26(3), pages 581-601, July.
    10. Olivier Damette & Beum-Jo Park, 2015. "Tobin Tax and Volatility: A Threshold Quantile Autoregressive Regression Framework," Review of International Economics, Wiley Blackwell, vol. 23(5), pages 996-1022, November.
    11. David Feldman & Xin Xu, 2018. "Equilibrium-based volatility models of the market portfolio rate of return (peacock tails or stotting gazelles)," Annals of Operations Research, Springer, vol. 262(2), pages 493-518, March.
    12. Niu, Weining & Zeng, Qingduo, 2018. "Corporate financing with loss aversion and disagreement," Finance Research Letters, Elsevier, vol. 27(C), pages 80-90.
    13. Guillaume Coqueret, 2016. "Empirical properties of a heterogeneous agent model in large dimensions," Post-Print hal-02088097, HAL.
    14. Wu, Xinyu & Xie, Haibin & Zhang, Huanming, 2022. "Time-varying risk aversion and renminbi exchange rate volatility: Evidence from CARR-MIDAS model," The North American Journal of Economics and Finance, Elsevier, vol. 61(C).

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    More about this item

    Keywords

    Boundedly rational agents; Time-varying and heterogeneous risk aversion; Herding; Adaptive beliefs system; Asset price dynamics; Excess volatility; Asymmetry in volatility;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General

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