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The Impact of Technical Analysis on Asset Price Dynamics

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Author Info
J.-H. Steffi Yang
Satchell, S.E.
Abstract

We study the impact of technical analysis in a context of heterogeneous, utility-maximising agents. A framework is provided to capture observed diversity in forecast estimates as a result of interaction between prior beliefs and asymmetric information. Using investment decisions of fundamentalists as a benchmark, agents’ optimal demand difference, which reflects expectation heterogeneity and the use of technical analysis, offers insights into the endogenous uncertainly in asset pricing behaviour. Technical analysis results in price feedback. We define a new family of feedback rules over cumulative distribution functions. Using bifurcation analysis, we show how prices asymptotically approach equilibrium and how significant feedback effects drive them off the equilibrium path. Both trend chasing strategy and contrarian strategy among technical trades are described in the model: the latter leads prices to overshoot the fundamental value with a high frequency; whereas in the former case, prices exhibit prolonged cyclic behaviour.

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Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0219.

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Length: 38
Date of creation: Jul 2002
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Handle: RePEc:cam:camdae:0219

Note: EM (updated August 2003)
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Web page: http://www.econ.cam.ac.uk/index.htm

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Related research
Keywords: price dynamics; heterogeneity; bifurcation; feedback trading;

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Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. 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. [Downloadable!] (restricted)
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  4. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August. [Downloadable!] (restricted)
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  5. J. Doyne Farmer & Shareen Joshi, 2000. "The price dynamics of common trading strategies," Quantitative Finance Papers cond-mat/0012419, arXiv.org. [Downloadable!]
  6. Grossman, Sanford J & Stiglitz, Joseph E, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, American Economic Association, vol. 70(3), pages 393-408, June.
  7. Xue-Zhong (Tony) He & Carl Chiarella, 2001. "Asset Price and Wealth Dynamics under Heterogeneous Expectations," CeNDEF Workshop Papers, January 2001 5A.2, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
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  8. John Y. Campbell, Robert J. Shiller, 1988. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 1(3), pages 195-228. [Downloadable!] (restricted)
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  9. W. Brian Arthur & John H. Holland & Blake LeBaron & Richard Palmer & Paul Taylor, 1996. "Asset Pricing Under Endogenous Expectation in an Artificial Stock Market," Working Papers 96-12-093, Santa Fe Institute.
  10. J. Doyne Farmer, 1998. "Market Force, Ecology, and Evolution," Research in Economics 98-12-117e, Santa Fe Institute. [Downloadable!]
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  11. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann,, . "The Survival of Noise Traders in Financial Markets," J. Bradford De Long's Working Papers _123, University of California at Berkeley, Economics Department. [Downloadable!]
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  12. J. Doyne Farmer & Shareen Joshi, 2000. "The Price Dynamics of Common Trading Strategies," Working Papers 00-12-069, Santa Fe Institute.
    Other versions:
  13. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Yang, J-H.S. & Satchell, S.E., 2003. "Endogenous Correlation," Cambridge Working Papers in Economics 0321, Faculty of Economics, University of Cambridge. [Downloadable!]
  2. J-H Steffi Yang, 2004. "The Markovian Dynamics of "Smart Money"," Econometric Society 2004 Far Eastern Meetings 797, Econometric Society. [Downloadable!]
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