Stock Price Fluctuations in an Agent-Based Model with Market Liquidity
We study an agent-based stock market model with heterogeneous agents and friction. Our model is based on that of Foellmer-Schweizer(1993): The process of a stock price in a discrete-time framework is determined by temporary equilibria via agents' excess demand functions, and the diffusion approximation approach is applied to characterize the continuous-time limit (as transaction intervals shorten) as a solution of the corresponding stochastic differential equation (SDE). In this paper we further make the assumption that some of the agents are bound by either short sale constraints or budget constraints. Then we show that the continuous-time process of the stock price can be derived from a certain SDE with oblique reflection. Moreover we find that the short sale (respectively, budget) constraint causes overpricing (respectively, underpricing).
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- J. Michael Harrison & David M. Kreps, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, Oxford University Press, vol. 92(2), pages 323-336.
- Bick, Avi, 1987. "On the Consistency of the Black-Scholes Model with a General Equilibrium Framework," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(03), pages 259-275, September.
- Diamond, Douglas W. & Verrecchia, Robert E., 1987. "Constraints on short-selling and asset price adjustment to private information," Journal of Financial Economics, Elsevier, vol. 18(2), pages 277-311, June.
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