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Moving average rules as a source of market instability

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  • Chiarella, Carl
  • He, Xue-Zhong
  • Hommes, Cars

Abstract

Despite the pervasiveness of the efficient markets paradigm in the academic finance literature, the use of various moving average (MA) trading rules remains popular with financial market practitioners. This paper proposes a stochastic dynamic financial market model in which demand for traded assets has both a fundamentalist and a chartist component. The chartist demand is governed by the difference between current price and a (long-run) MA. Our simulations show that the MA is a source of market instability, and the interaction of the MA and market noises can lead to the tendency for the market price to take long excursions away from the fundamental. The model reveals various market price phenomena, the coexistence of apparent market efficiency and a large chartist component, price resistance levels, long memory and skewness and kurtosis of returns.

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Bibliographic Info

Article provided by Elsevier in its journal Physica A: Statistical Mechanics and its Applications.

Volume (Year): 370 (2006)
Issue (Month): 1 ()
Pages: 12-17

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Handle: RePEc:eee:phsmap:v:370:y:2006:i:1:p:12-17

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Web page: http://www.journals.elsevier.com/physica-a-statistical-mechpplications/

Related research

Keywords: Moving averages; Fundamentalists; Trend followers; Stability; Evolutionary switching;

References

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  1. Brock, W. & Lakonishok, J. & Lebaron, B., 1991. "Simple Technical Trading Rules And The Stochastic Properties Of Stock Returns," Working papers 90-22, Wisconsin Madison - Social Systems.
  2. 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.
  3. Chiarella, C. & He, X.-Z. & Hommes, C.H., 2004. "A Dynamic Analysis of Moving Average Rules," CeNDEF Working Papers 04-14, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  4. Blume, Lawrence & Easley, David & O'Hara, Maureen, 1994. " Market Statistics and Technical Analysis: The Role of Volume," Journal of Finance, American Finance Association, vol. 49(1), pages 153-81, March.
  5. Carl Chiarella, 1992. "The Dynamics of Speculative Behaviour," Working Paper Series 13, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  6. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
  7. Chiarella, Carl & He, Xue-Zhong, 2003. "Heterogeneous Beliefs, Risk, And Learning In A Simple Asset-Pricing Model With A Market Maker," Macroeconomic Dynamics, Cambridge University Press, vol. 7(04), pages 503-536, September.
  8. Brock, William A. & Hommes, Cars H., 1998. "Heterogeneous beliefs and routes to chaos in a simple asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 22(8-9), pages 1235-1274, August.
  9. Day, R. & Huang, W., 1988. "Bulls, Bears And Market Sheep," Papers m8822, Southern California - Department of Economics.
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Citations

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Cited by:
  1. Hermsen, Oliver & Witte, Björn-Christopher & Westerhoff, Frank, 2010. "Disclosure requirements, the release of new information and market efficiency: new insights from agent-based models," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 4(7), pages 1-26.
  2. Franke, Reiner, 2010. "On the specification of noise in two agent-based asset pricing models," Journal of Economic Dynamics and Control, Elsevier, vol. 34(6), pages 1140-1152, June.
  3. Carl Chiarella & Xue-Zhong He & Min Zheng, 2007. "The Stochastic Dynamics of Speculative Prices," Research Paper Series 208, Quantitative Finance Research Centre, University of Technology, Sydney.
  4. Anufriev, Mikhail & Dindo, Pietro, 2010. "Wealth-driven selection in a financial market with heterogeneous agents," Journal of Economic Behavior & Organization, Elsevier, vol. 73(3), pages 327-358, March.
  5. Chiarella, Carl & He, Xue-Zhong & Pellizzari, Paolo, 2012. "A Dynamic Analysis Of The Microstructure Of Moving Average Rules In A Double Auction Market," Macroeconomic Dynamics, Cambridge University Press, vol. 16(04), pages 556-575, September.
  6. Malliaris, A.G. & Kyrtsou, C., 2009. "Editorial introduction of the special issue: "Energy sector pricing and macroeconomic dynamics"," Energy Economics, Elsevier, vol. 31(6), pages 825-826, November.
  7. Kyrtsou, Catherine, 2008. "Re-examining the sources of heteroskedasticity: The paradigm of noisy chaotic models," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 387(27), pages 6785-6789.
  8. Chiarella, Carl & He, Xue-Zhong & Zheng, Min, 2011. "An analysis of the effect of noise in a heterogeneous agent financial market model," Journal of Economic Dynamics and Control, Elsevier, vol. 35(1), pages 148-162, January.

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