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Excess Volatility and Herding in an Artificial Financial Market: Analytical Approach and Estimation

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  • Alfarano, Simone
  • Lux, Thomas
  • Wagner, Friedrich

Abstract

Several agent-based models have been proposed in the economic literature to explain the key stylized facts of financial data: heteroscedasticity, fat tails of returns and long-range dependence of volatility. Agentbased models view these empirical regularities as emerging properties of interacting groups of boundedly rational agents in financial markets. The complexity of these interacting agent models has largely constrained their analytical treatment, limiting their analysis mainly to Monte Carlo simulations. In order to overcome this limitation, we introduce a ‘minimalist’ model of an artificial financial market, along the lines of our previous contributions, based on herding behavior among two types of traders. The simplicity of the model allows for an almost complete analytical characterization of both conditional and unconditional statistical properties of prices and returns. Moreover, the underlying parameters of the model can be estimated directly, which permits an assessment of its goodness-of-fit for empirical data. While the performance of the model for domestic stock markets has been the focus of a previous contribution, in this paper we report results for selected exchange rates against the US dollar.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 24719.

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Date of creation: 2010
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Handle: RePEc:pra:mprapa:24719

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Related research

Keywords: Herd Behavior; Speculative Dynamics; Fat Tails; Volatility Clustering.;

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References

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  1. Aoki,Masanao, 2001. "Modeling Aggregate Behavior and Fluctuations in Economics," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521781268.
  2. Alfarano, Simone & Lux, Thomas & Wagner, Friedrich, 2005. "Time-variation of higher moments in a financial market with heterogeneous agents: An analytical approach," Economics Working Papers, Christian-Albrechts-University of Kiel, Department of Economics 2005,14, Christian-Albrechts-University of Kiel, Department of Economics.
  3. Simone Alfarano & Thomas Lux & Friedrich Wagner, 2005. "Estimation of Agent-Based Models: The Case of an Asymmetric Herding Model," Computational Economics, Society for Computational Economics, Society for Computational Economics, vol. 26(1), pages 19-49, August.
  4. Beja, Avraham & Goldman, M Barry, 1980. " On the Dynamic Behavior of Prices in Disequilibrium," Journal of Finance, American Finance Association, American Finance Association, vol. 35(2), pages 235-48, May.
  5. Simone Alfarano & Thomas Lux, 2002. "A minimal noise trader model with realistic time series," Computing in Economics and Finance 2002, Society for Computational Economics 317, Society for Computational Economics.
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Cited by:
  1. S. Alfarano & T. Lux & F. Wagner, 2007. "Empirical validation of stochastic models of interacting agents," The European Physical Journal B - Condensed Matter and Complex Systems, Springer, Springer, vol. 55(2), pages 183-187, 01.
  2. Alfarano, Simone & Lux, Thomas & Wagner, Friedrich, 2006. "Estimation of a simple agent-based model of financial markets: An application to Australian stock and foreign exchange data," Physica A: Statistical Mechanics and its Applications, Elsevier, Elsevier, vol. 370(1), pages 38-42.

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