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Moving average rules as a source of market instability

  • Chiarella, Carl
  • He, Xue-Zhong
  • Hommes, Cars

Despite the pervasiveness of the efficient markets paradigm in the academic finance literature, the use of various moving average (MA) trading rules remains popular with financial market practitioners. This paper proposes a stochastic dynamic financial market model in which demand for traded assets has both a fundamentalist and a chartist component. The chartist demand is governed by the difference between current price and a (long-run) MA. Our simulations show that the MA is a source of market instability, and the interaction of the MA and market noises can lead to the tendency for the market price to take long excursions away from the fundamental. The model reveals various market price phenomena, the coexistence of apparent market efficiency and a large chartist component, price resistance levels, long memory and skewness and kurtosis of returns.

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File URL: http://www.sciencedirect.com/science/article/pii/S0378437106004389
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Article provided by Elsevier in its journal Physica A: Statistical Mechanics and its Applications.

Volume (Year): 370 (2006)
Issue (Month): 1 ()
Pages: 12-17

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Handle: RePEc:eee:phsmap:v:370:y:2006:i:1:p:12-17
Contact details of provider: Web page: http://www.journals.elsevier.com/physica-a-statistical-mechpplications/

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  1. Brock, W. & Lakonishok, J. & Lebaron, B., 1991. "Simple Technical Trading Rules And The Stochastic Properties Of Stock Returns," Working papers 90-22, Wisconsin Madison - Social Systems.
  2. Day, R. & Huang, W., 1988. "Bulls, Bears And Market Sheep," Papers m8822, Southern California - Department of Economics.
  3. Chiarella, C. & He, X.-Z. & Hommes, C.H., 2004. "A Dynamic Analysis of Moving Average Rules," CeNDEF Working Papers 04-14, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  4. Carl Chiarella, 1992. "The Dynamics of Speculative Behaviour," Working Paper Series 13, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  5. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
  6. Carl Chiarella & Xue-Zhong He, 1999. "Heterogeneous Beliefs, Risks and Learning in a Simple Asset Pricing Model," Research Paper Series 18, Quantitative Finance Research Centre, University of Technology, Sydney.
  7. Brock, W.A. & Hommes, C.H., 1996. "Hetergeneous Beliefs and Routes to Chaos in a Simple Asset Pricing Model," Working papers 9621, Wisconsin Madison - Social Systems.
  8. Chiarella, Carl & He, Xue-Zhong, 2003. "Heterogeneous Beliefs, Risk, And Learning In A Simple Asset-Pricing Model With A Market Maker," Macroeconomic Dynamics, Cambridge University Press, vol. 7(04), pages 503-536, September.
  9. Blume, Lawrence & Easley, David & O'Hara, Maureen, 1994. " Market Statistics and Technical Analysis: The Role of Volume," Journal of Finance, American Finance Association, vol. 49(1), pages 153-81, March.
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