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A Nonlinear Structural Model for Volatility Clustering

In: Long Memory in Economics

Author

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  • Andrea Gaunersdorfer

    (University of Vienna)

  • Cars Hommes

    (University of Amsterdam)

Abstract

Summary A simple nonlinear structural model of endogenous belief heterogeneity is proposed. News about fundamentals is an IID random process, but nevertheless volatility clustering occurs as an endogenous phenomenon caused by the interaction between different types of traders, fundamentalists and technical analysts. The belief types are driven by adaptive, evolutionary dynamics according to the success of the prediction strategies as measured by accumulated realized profits, conditioned upon price deviations from the rational expectations fundamental price. Asset prices switch irregularly between two different regimes — periods of small price fluctuations and periods of large price changes triggered by random news and reinforced by technical trading — thus, creating time varying volatility similar to that observed in real financial data.

Suggested Citation

  • Andrea Gaunersdorfer & Cars Hommes, 2007. "A Nonlinear Structural Model for Volatility Clustering," Springer Books, in: Gilles Teyssière & Alan P. Kirman (ed.), Long Memory in Economics, pages 265-288, Springer.
    • Handle: RePEc:spr:sprchp:978-3-540-34625-8_9
    DOI: 10.1007/978-3-540-34625-8_9
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