This paper attempts to study the dynamics of a simple discounted present value asset price model where agents have different risk attitudes and follow different expectation formulation schemes for both first and second moments of the price distribution. Instead of using a Walrasian auctioneer scenario as the market clearing mechanism, a market maker scenario is used. In particular, the paper concentrates on models of fundamentalists and trend traders who follow least squares learning processes. An analysis is made of the effects of lag lengths on the stability of the fundamental equilibrium. Some necessary and/or sufficient conditions on the stability of the fundamental equilibrium associated with the speed of the adjustment of the market maker, different risk attitudes and different risk attitudes and different values of lags (used in the learning process) are established. The results lead to the following observations: (I) Compared with the findings with the Walrasian market clearing scenario in Brock and Hommes [8] and Chiarella and He [14], different price dynamics are obtained when the speed of the adjustment of the market maker increases and, in particular, when the contrarians are involved in the model; (ii) In contrast to homogeneous beliefs, where the larger is the lag length the more stable is that in general (for both the Walrasian and the market maker equilibrium) different lag lengths can complicate the price dynamics; (iii) In the model of trend followers versus contrarians, the stability of the fundamental equilibrium is determined by risk-adjusted aggregated extrapolation rates. This indicates that although every individual forecasting rule may lead to divergence from the equilibrium, these may "cancel out" in the aggregate and the actual dynamics with learning may thus be locally stable. On the other hand, only a small group of traders with expectation functions involving significant divergence can in fact destabilize the whole system.
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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number
35.
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990.
"Noise Trader Risk in Financial Markets,"
Journal of Political Economy,
University of Chicago Press, vol. 98(4), pages 703-38, August.
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Other versions:
Evans, George W. & Honkapohja, Seppo, 1999.
"Learning dynamics,"
Handbook of Macroeconomics,
in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 7, pages 449-542
Elsevier.
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Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.) This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.