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Nonlinear dynamical model of regime switching between conventions and business cycles

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  • Yukalov, V.I.
  • Sornette, D.
  • Yukalova, E.P.
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    Abstract

    We introduce and study a non-equilibrium continuous-time dynamical model of the price of a single asset traded by a population of heterogeneous interacting agents in the presence of uncertainty and regulatory constraints. The model takes into account (i) the price formation delay between decision and investment by the second-order nature of the dynamical equations, (ii) the linear and nonlinear mean-reversal or their contrarian in the form of speculative price trading, (iii) market friction, (iv) uncertainty in the fundamental value that controls the amplitude of mispricing, (v) nonlinear speculative momentum effects and (vi) market regulations that may limit large mispricing drifts. We find markets with coexisting equilibrium, conventions and business cycles that depend on (a) the relative strength of value-investing versus momentum-investing, (b) the level of uncertainty on the fundamental value, and (c) the degree of market regulation. The stochastic dynamics is characterized by nonlinear geometric random walk-like processes with spontaneous regime shifts between different conventions or business cycles. This model provides a natural dynamical framework to model regime shifts between different market phases that may result from the interplay between the effects (i-vi).

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Economic Behavior & Organization.

    Volume (Year): 70 (2009)
    Issue (Month): 1-2 (May)
    Pages: 206-230

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    Handle: RePEc:eee:jeborg:v:70:y:2009:i:1-2:p:206-230

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

    Related research

    Keywords: Prices Business fluctuations and cycles Simultaneous equation models General aggregative models;

    References

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    Cited by:
    1. D. Sornette, 2014. "Physics and Financial Economics (1776-2014): Puzzles, Ising and Agent-Based models," Papers 1404.0243, arXiv.org.

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