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Price Dynamics in Market with Heterogeneous Investment Horizons and Boundedly Rational Traders

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  • Thierry Chauveau

    (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)

  • Alexander Subbotin

    (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)

Abstract

This paper studies the effects of multiple investment horizons and investors' bounded rationality on the price dynamics. We consider a pure exchange economy with one risky asset, populated with agents maximizing CRRA-type expected utility of wealth over discrete investment periods. An investor's demand for the risky asset may depend on the historical returns, so that our model encompasses a wide range of behaviorist patterns. The necessary conditions, under which the risky return can be a stationary iid process, are established. The compatibility of these conditions with different types of demand functions in the heterogeneous agents' framework are explored. We find that conditional volatility of returns cannot be constant in many generic situations, especially if agents with different investment horizons operate on the market. In the latter case the return process can display conditional heteroscedasticity, even if all investors are so-called "fundamentalists" and their demand for the risky asset is subject to exogenous iid shocks. We show that the heterogeneity of investment horizons can be a possible explanation of different stylized patterns in stock returns, in particular, mean-reversion and volatility clustering.

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  • Thierry Chauveau & Alexander Subbotin, 2010. "Price Dynamics in Market with Heterogeneous Investment Horizons and Boundedly Rational Traders," Post-Print halshs-00497427, HAL.
    • Handle: RePEc:hal:journl:halshs-00497427
    Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-00497427
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    References listed on IDEAS

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    1. Xue, Yi & Gençay, Ramazan, 2012. "Trading frequency and volatility clustering," Journal of Banking & Finance, Elsevier, vol. 36(3), pages 760-773.

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