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

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  • Carl Chiarella
  • Tony He

Abstract

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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Suggested Citation

  • Carl Chiarella & Tony He, 2002. "An Adaptive Model on Asset Pricing and Wealth Dynamics with Heterogeneous Trading Strategies," Computing in Economics and Finance 2002 135, Society for Computational Economics.
  • Handle: RePEc:sce:scecf2:135
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    References listed on IDEAS

    as
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    Citations

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    Cited by:

    1. Anufriev, M. & Dindo, P.D.E., 2007. "Wealth Selection in a Financial Market with Heterogeneous Agents," CeNDEF Working Papers 07-10, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
    2. Orlando Gomes, 2004. "A Continuous-Time Asset Pricing Model with Boundedly Rational Heterogeneous Agents," Finance 0409055, EconWPA.
    3. Mikhail Anufriev, 2008. "Wealth-driven competition in a speculative financial market: examples with maximizing agents," Quantitative Finance, Taylor & Francis Journals, vol. 8(4), pages 363-380.
    4. Kukacka, Jiri & Barunik, Jozef, 2013. "Behavioural breaks in the heterogeneous agent model: The impact of herding, overconfidence, and market sentiment," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 392(23), pages 5920-5938.
    5. Demary, Markus, 2007. "A Heterogenous Agents Model Usable for the Analysis of Currency Transaction Taxes," Economics Working Papers 2007-27, Christian-Albrechts-University of Kiel, Department of Economics.
    6. Xue-Zhong He & Youwei Li, 2017. "The adaptiveness in stock markets: testing the stylized facts in the DAX 30," Journal of Evolutionary Economics, Springer, pages 1071-1094.
    7. Amilon, Henrik, 2008. "Estimation of an adaptive stock market model with heterogeneous agents," Journal of Empirical Finance, Elsevier, vol. 15(2), pages 342-362, March.
    8. Mikhail Anufriev & Giulio Bottazzi & Francesca Pancotto, 2004. "Price and Wealth Asymptotic Dynamics with CRRA Technical Trading Strategies," LEM Papers Series 2004/23, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    9. Anufriev, Mikhail & Bottazzi, Giulio & Pancotto, Francesca, 2006. "Equilibria, stability and asymptotic dominance in a speculative market with heterogeneous traders," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1787-1835.
    10. Demary Markus, 2008. "Who Does a Currency Transaction Tax Harm More: Short-Term Speculators or Long-Term Investors?," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 228(2-3), pages 228-250, April.
    11. Chiarella, Carl & Dieci, Roberto & Gardini, Laura, 2006. "Asset price and wealth dynamics in a financial market with heterogeneous agents," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1755-1786.
    12. Markus Demary, 2007. "Who Do Currency Transaction Taxes Harm More: Short-Term Speculators or Long-Term Investors?," Working Papers wp07-05, Warwick Business School, Finance Group.
    13. Lux, Thomas & Schornstein, Sascha, 2005. "Genetic learning as an explanation of stylized facts of foreign exchange markets," Journal of Mathematical Economics, Elsevier, vol. 41(1-2), pages 169-196, February.
    14. Anufriev, Mikhail & Dindo, Pietro, 2010. "Wealth-driven selection in a financial market with heterogeneous agents," Journal of Economic Behavior & Organization, Elsevier, vol. 73(3), pages 327-358, March.
    15. Markus Demary, 2006. "Transaction Taxes, Traders?Behavior and Exchange Rate Risks," Working Papers wp06-13, Warwick Business School, Finance Group.
    16. Gomes, Orlando, 2006. "Heterogeneous Researchers in a Two-Sector Representative Consumer Economy," Revista Brasileira de Economia - RBE, FGV/EPGE - Escola Brasileira de Economia e Finan├žas, Getulio Vargas Foundation (Brazil), vol. 60(2), November.
    17. Anufriev, M. & Dindo, P.D.E., 2006. "Equilibrium Return and Agents' Survival in a Multiperiod Asset Market: Analytic Support of a Simulation Model," CeNDEF Working Papers 06-03, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
    18. Carl Chiarella & Roberto Dieci & Xue-Zhong He, 2008. "Heterogeneity, Market Mechanisms, and Asset Price Dynamics," Research Paper Series 231, Quantitative Finance Research Centre, University of Technology, Sydney.
    19. repec:eee:dyncon:v:85:y:2017:i:c:p:21-45 is not listed on IDEAS
    20. Youwei Li & Bas Donkers, 2004. "The Econometric Analysis of Microscopic Simulation Models," Computing in Economics and Finance 2004 195, Society for Computational Economics.
    21. Blake LeBaron, 2011. "Active and Passive Learning in Agent-based Financial Markets," Eastern Economic Journal, Palgrave Macmillan;Eastern Economic Association, vol. 37(1), pages 35-43.
    22. Park, Beum-Jo, 2014. "Time-varying, heterogeneous risk aversion and dynamics of asset prices among boundedly rational agents," Journal of Banking & Finance, Elsevier, vol. 43(C), pages 150-159.
    23. Kukacka, Jiri & Barunik, Jozef, 2017. "Estimation of financial agent-based models with simulated maximum likelihood," Journal of Economic Dynamics and Control, Elsevier, vol. 85(C), pages 21-45.
    24. Demary, Markus, 2010. "Transaction taxes and traders with heterogeneous investment horizons in an agent-based financial market model," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 4, pages 1-44.
    25. Mikhail Anufriev & Giulio Bottazzi, 2005. "Price and Wealth Dynamics in a Speculative Market with an Arbitrary Number of Generic Technical Traders," LEM Papers Series 2005/06, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.

    More about this item

    Keywords

    Asset pricing; wealth dynamics; profitability; trading strategies;

    JEL classification:

    • C20 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - General

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