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On the Role of Memory in an Asset Pricing Model with Heterogeneous Beliefs

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  • Miroslav Verbic

    (Institute for Economic Research, Ljubljana, Slovenia)

Abstract

The paper discusses the role of memory in an asset pricing model with heterogeneous beliefs. In particular, we were interested in how memory in the fitness measure affects the stability of evolutionary adaptive systems and the survival of technical trading. In order to obtain an insight into this matter, two cases were analyzed: a two-type case of fundamentalists versus contrarians and a three-type case of fundamentalists versus opposite biases. It has been established that increasing memory strength has a stabilizing effect on dynamics, though it is not able to eliminate speculative traders’ short-run profit-seeking behaviour from the market. Furthermore, opposite biases do not seem to lead to chaotic dynamics, even when there are no costs for fundamentalists. Apparently some (strong) trend extrapolator beliefs are needed in order to trigger chaotic asset price fluctuations.

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Bibliographic Info

Article provided by Institute of Public Finance in its journal Financial Theory and Practice.

Volume (Year): 32 (2008)
Issue (Month): 2 ()
Pages: 195-229

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Handle: RePEc:ipf:finteo:v:32:y:2008:i:2:p:195-229

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Keywords: asset pricing; biased beliefs; contrarians; fitness measure; fundamentalists; heterogeneous beliefs; memory strength; stability;

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  1. Chiarella, Carl & He, Xue-Zhong, 2002. "Heterogeneous Beliefs, Risk and Learning in a Simple Asset Pricing Model," Computational Economics, Society for Computational Economics, vol. 19(1), pages 95-132, February.
  2. Cars H. Hommes, 2005. "Heterogeneous Agent Models in Economics and Finance," Tinbergen Institute Discussion Papers 05-056/1, Tinbergen Institute.
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  4. Hommes, Cars & Huang, Hai & Wang, Duo, 2005. "A robust rational route to randomness in a simple asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 29(6), pages 1043-1072, June.
  5. Peiyuan Zhu & Carl Chiarella & Tony He, 2003. "Fading Memory Learning in the Cobweb Model with Risk Averse Heterogeneous Producers," Computing in Economics and Finance 2003 31, Society for Computational Economics.
  6. Gaunersdorfer, Andrea & Hommes, Cars H. & Wagener, Florian O.O., 2008. "Bifurcation routes to volatility clustering under evolutionary learning," Journal of Economic Behavior & Organization, Elsevier, vol. 67(1), pages 27-47, July.
  7. Honkapohja, S. & Mitra, K., 1999. "Learning with Bounded Memory in Stochastic Models," University of Helsinki, Department of Economics 456, Department of Economics.
  8. Hommes, Cars & Sonnemans, Joep & Tuinstra, Jan & van de Velden, Henk, 2008. "Expectations and bubbles in asset pricing experiments," Journal of Economic Behavior & Organization, Elsevier, vol. 67(1), pages 116-133, July.
  9. repec:att:wimass:9530 is not listed on IDEAS
  10. Carl Chiarella & Tony He & Cars H. Hommes, 2005. "A Dynamic Analysis of Moving Average Rules," Tinbergen Institute Discussion Papers 05-057/1, Tinbergen Institute.
  11. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-617, December.
  12. William A. Brock & Cars H. Hommes, 1997. "A Rational Route to Randomness," Econometrica, Econometric Society, vol. 65(5), pages 1059-1096, September.
  13. De Grauwe, Paul & Grimaldi, Marianna, 2006. "Exchange rate puzzles: A tale of switching attractors," European Economic Review, Elsevier, vol. 50(1), pages 1-33, January.
  14. Brock, W.A. & Hommes, C.H. & Wagener, F.O.O., 2002. "Evolutionary dynamics in markets with many trader types," CeNDEF Working Papers 02-10, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  15. LeBaron, Blake, 2000. "Agent-based computational finance: Suggested readings and early research," Journal of Economic Dynamics and Control, Elsevier, vol. 24(5-7), pages 679-702, June.
  16. Gaunersdorfer, Andrea, 2000. "Endogenous fluctuations in a simple asset pricing model with heterogeneous agents," Journal of Economic Dynamics and Control, Elsevier, vol. 24(5-7), pages 799-831, June.
  17. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
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