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An Adaptive Model on Asset Pricing and Wealth Dynamics with Heterogeneous Trading Strategies

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Author Info
Carl Chiarella () (School of Finance and Economics, University of Technology, Sydney)
Xue-Zhong He () (School of Finance and Economics, University of Technology, Sydney)

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Abstract

This paper develops an adaptive model on asset pricing and wealth dynamic of a financial market with heterogeneous agents and examines the profitability of momentum and contrarian trading strategies. In order to characterize asset price, wealth dynamics and rational adaptiveness arising from the interaction of heterogeneous agents with CRRA utility, an adaptive discrete time equilibrium model in terms of return ad wealth proportions (among heterogeneous representative agents) is established. Taking trend followers and contrarians as the main hetergeneous agents in the model, the profitability of momentum and contrarian trading strategies is analyzed. Our results show the capability of the model to characterize some of the existing evidence on many of anomailies observed in financial markets, including the profitability of momentum trading strategies over short time intervals, rational adaptiveness of agents, overconfidence and underreaction, overreaction and herd behavior, excess volatility, and volatility clustering.

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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 84.

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Date of creation: 01 Jun 2002
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Handle: RePEc:uts:rpaper:84

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Related research
Keywords: asset pricing; wealth dynamics; hetergeneity; adaptiveness; profitability; momentum trading strategies; contrarian trading strategies;

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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.:
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    Other versions:
  4. Day, Richard H. & Huang, Weihong, 1990. "Bulls, bears and market sheep," Journal of Economic Behavior & Organization, Elsevier, vol. 14(3), pages 299-329, December. [Downloadable!] (restricted)
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  5. J. Doyne Farmer, 1999. "Physicists Attempt to Scale the Ivory Towers of Finance," Working Papers 99-10-073, Santa Fe Institute.
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    Other versions:
  7. Chiarella, Carl & He, Xue-Zhong, 2002. "Heterogeneous Beliefs, Risk and Learning in a Simple Asset Pricing Model," Computational Economics, Springer, vol. 19(1), pages 95-132, February. [Downloadable!]
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  8. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September. [Downloadable!] (restricted)
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  14. LeBaron, Blake, 2000. "Agent-based computational finance: Suggested readings and early research," Journal of Economic Dynamics and Control, Elsevier, vol. 24(5-7), pages 679-702, June. [Downloadable!] (restricted)
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  18. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March. [Downloadable!] (restricted)
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  23. Carl Chiarella & Xue-Zhong He, 2000. "Heterogeneous Beliefs, Risk and Learning in a Simple Asset Pricing Model with a Market Maker," Research Paper Series 35, Quantitative Finance Research Centre, University of Technology, Sydney. [Downloadable!]
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  24. Lux, Thomas, 1995. "Herd Behaviour, Bubbles and Crashes," Economic Journal, Royal Economic Society, vol. 105(431), pages 881-96, July. [Downloadable!] (restricted)
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    Other versions:
Full references

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.)

  1. Carl Chiarella & Roberto Dieci & Xue-Zhong He, 2008. "Heterogeneity, Market Mechanisms, and Asset Price Dynamics," Research Paper Series 231, Quantitative Finance Research Centre, University of Technology, Sydney. [Downloadable!]
  2. Youwei Li & Bas Donkers, 2004. "The Econometric Analysis of Microscopic Simulation Models," Computing in Economics and Finance 2004 195, Society for Computational Economics. [Downloadable!]
    Other versions:
  3. Demary, Markus, 2006. "Transaction taxes, traders' behavior and exchange rate risks," Economics Working Papers 2006,14, Christian-Albrechts-University of Kiel, Department of Economics. [Downloadable!]
    Other versions:
  4. Mikhail Anufriev & Giulio Bottazzi & Francesca Pancotto, 2004. "Price and Wealth Asymptotic Dynamics with CRRA Technical Trading Strategies," LEM Papers Series 2004/23, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy. [Downloadable!]
  5. Orlando Gomes, 2004. "Heterogeneous Researchers in a Two-Sector Representative Consumer Economy," GE, Growth, Math methods 0409009, EconWPA. [Downloadable!]
    Other versions:
  6. Orlando Gomes, 2004. "A Continuous-Time Asset Pricing Model with Boundedly Rational Heterogeneous Agents," Finance 0409055, EconWPA. [Downloadable!]
  7. Demary, Markus, 2007. "A Heterogenous Agents Model Usable for the Analysis of Currency Transaction Taxes," Economics Working Papers 2007,27, Christian-Albrechts-University of Kiel, Department of Economics. [Downloadable!]
    Other versions:
  8. Henrik Amilon, 2003. "Estimation of an Adaptive Stock Market Model with Heterogeneous Agents," Research Paper Series 107, Quantitative Finance Research Centre, University of Technology, Sydney. [Downloadable!]
  9. Mikhail Anufriev & Giulio Bottazzi, 2005. "Price and Wealth Dynamics in a Speculative Market with an Arbitrary Number of Generic Technical Traders," LEM Papers Series 2005/06, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy. [Downloadable!]
  10. Amilon, Henrik, 2005. "Estimation of an Adaptive Stock Market Model with Heterogeneous Agents," Working Paper Series 177, Sveriges Riksbank (Central Bank of Sweden). [Downloadable!]
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