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Herding, A-synchronous Updating and Heterogeneity in Memory in a CBS

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Author Info

  • Cees Diks

    ()
    (Faculty of Economics and Econometrics, Universiteit van Amsterdam)

  • Roy van der Weide

    ()
    (Faculty of Economics and Econometrics, Universiteit van Amsterdam)

Abstract

This paper considers a simple Continuous Beliefs System (CBS) toinvestigate the effects on price dynamics of several behavioralassumptions: (i) herd behaviour; (ii) a-synchronous updating ofbeliefs; and (iii) heterogeneity in time horizons (memory) amongagents. The recently introduced concept of a CBS allows one to model the co-evolution of prices and the beliefs distribution explicitly, while keeping track of the unpredictable nature of individual preferences (Diks and Van der Weide, 2003). As a benchmark model we take a simple CBS, which in a market withmany traders exhibits a random walk driven by news.Using the explicit nature of the dynamics of the CBS we show that the introduction of herding modifies the random walk to an ARIMA($0,1,1$) process, which is observationally equivalent to areduction of the number of market participants. In terms of returns the model predicts MA(1) structure with a negative coeffient. Asynchronous updating leads to an MA(1) model for returns with GARCH($1,1$) innovations, and predicts a relation between the ARCH and GARCH coefficients. Heterogeneity in memory leads to long-range dependence in returns. In the empirical section we perform a modest `reality check' concerning the predicted sign of the MA coefficient and the relation between the ARCH and GARCH coefficients for exchange rate data.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 03-103/1.

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Date of creation: 19 Dec 2003
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Handle: RePEc:dgr:uvatin:20030103

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Keywords: Continuous beliefs systems; Random dynamical systems; Heterogeneity; Herding; ARIMA; GARCH; Long-range dependence;

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