A Classical Model of Speculative Asset Price Dynamics

In retrospect, the experimental findings on competitive market behavior called for a revival of the old, classical, view of competition as a collective higgling and bargaining pro-cess (as opposed to price-taking behaviors) founded on reservation prices (in place of the utility function). In this paper, we specialize the classical methodology to deal with specula-tion, an important impediment to price stability. The model involves typical features of a field or lab asset market setup and lends itself to an experimental test of its specific predic-tions; here we use the model to explain three general stylized facts, well established both empirically and experimentally: the excess, fat-tailed, and clustered volatility of speculative asset prices. The fat tails emerge in the model from the amplifying nature of speculation, leading to a random-coefficient autoregressive return process (and power-law tails); the volatility clustering is due to the traders’ long memory of news; bubbles are a persistent phenomenon in the model, and, assuming the standard lab present value pattern, the bub-ble size increases with the proportion of speculators and decreases with the trading horizon.