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Herding, a-synchronous updating and heterogeneity in memory in a CBS

  • Diks, Cees
  • van der Weide, Roy

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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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 29 (2005)
Issue (Month): 4 (April)
Pages: 741-763

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Handle: RePEc:eee:dyncon:v:29:y:2005:i:4:p:741-763
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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