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An Adaptive Model on Asset Pricing and Wealth Dynamics with Heterogeneous Trading Strategies

  • Carl Chiarella
  • Tony He

This paper develops an adaptive model on asset pricing and wealth dynamic of a financial market with heterogeneous agents and examines the profitability of momentum and contrarian trading strategies. In order to characterize asset price, wealth dynamics and rational adaptiveness arising from the interaction of heterogeneous agents with CRRA utility, an adaptive discrete time equilibrium model in terms of return ad wealth proportions (among heterogeneous representative agents) is established. Taking trend followers and contrarians as the main hetergeneous agents in the model, the profitability of momentum and contrarian trading strategies is analyzed. Our results show the capability of the model to characterize some of the existing evidence on many of anomailies observed in financial markets, including the profitability of momentum trading strategies over short time intervals, rational adaptiveness of agents, overconfidence and underreaction, overreaction and herd behavior, excess volatility, and volatility clustering.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2002 with number 135.

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Date of creation: 01 Jul 2002
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Handle: RePEc:sce:scecf2:135
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  1. repec:att:wimass:9530 is not listed on IDEAS
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  8. K. Rouwenhorst, 1996. "International Momentum Strategies," Yale School of Management Working Papers ysm36, Yale School of Management, revised 01 Feb 2008.
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  20. Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December.
  21. Xue-Zhong (Tony) He & Carl Chiarella, 2001. "Asset Price and Wealth Dynamics under Heterogeneous Expectations," CeNDEF Workshop Papers, January 2001 5A.2, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  22. Lux, Thomas, 1995. "Herd Behaviour, Bubbles and Crashes," Economic Journal, Royal Economic Society, vol. 105(431), pages 881-96, July.
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  25. Reiner Franke & Tim Nesemann, 1999. "Two destabilizing strategies may be jointly stabilizing," Journal of Economics, Springer, vol. 69(1), pages 1-18, February.
  26. 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.
  27. Brock, W.A. & Hommes, C.H., 1996. "A Rational Route to Randomness," Working papers 9530r, Wisconsin Madison - Social Systems.
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