The Impact of Technical Analysis on Asset Price Dynamics
AbstractWe 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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Bibliographic InfoPaper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0219.
Date of creation: Jul 2002
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Note: EM (updated August 2003)
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price dynamics; heterogeneity; bifurcation; feedback trading;
Find related papers by JEL classification:
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
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