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Financial Markets as Nonlinear Adaptive Evolutionary Systems

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  • Cars H. Hommes

    ()
    (University of Amsterdam)

Abstract

Recent work on complex adaptive systems for modeling financialmarkets is surveyed. Financia1 markets areviewed as evolutionary systems between different, competing tradingstrategies. Agents are boundedly rational inthe sense that they tend to follow strategies that have performedwell, according to realized profits or accumulatedwea1th, in the recent past. Simple technical trading rules maysurvive evolutionary competition in a heterogeneousworld where prices and beliefs co-evolve over time. The evolutionarymodel explains stylized facts, such as fat tails,volatility clustering and long memory, of real financial series.Although our adaptive belief systems are very simple, they can matchthe autocorrelation patterns of returns,squared returns and absolute returns of 40 years of S&P 500 data"Some recent laboratory work on expectationsformation in an asset pricing framework is also discussed.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 01-014/1.

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Date of creation: 06 Feb 2001
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Handle: RePEc:dgr:uvatin:20010014

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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. Farmer, J. Doyne & Joshi, Shareen, 2002. "The price dynamics of common trading strategies," Journal of Economic Behavior & Organization, Elsevier, vol. 49(2), pages 149-171, October.
  3. Wang, Jiang, 1994. "A Model of Competitive Stock Trading Volume," Journal of Political Economy, University of Chicago Press, vol. 102(1), pages 127-68, February.
  4. Xue-Zhong He & Carl Chiarella, 1999. "Heterogeneous Beliefs, Risk and Learning in a Simple Asset-Pricing Model," Computing in Economics and Finance 1999 223, Society for Computational Economics.
  5. Brock, William A & LeBaron, Blake D, 1996. "A Dynamic Structural Model for Stock Return Volatility and Trading Volume," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 94-110, February.
  6. Carl Chiarella, 1992. "The Dynamics of Speculative Behaviour," Working Paper Series 13, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  7. Sunder, S., 1992. "Experimental Asset Markets: A Survey," GSIA Working Papers 1992-19, Carnegie Mellon University, Tepper School of Business.
  8. Baak, Saang Joon, 1999. "Tests for bounded rationality with a linear dynamic model distorted by heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 23(9-10), pages 1517-1543, September.
  9. 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.
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