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Long Memory, Heterogeneity, and Trend Chasing

Author

Listed:
  • Youwei Li
  • Xue-Zhong He

Abstract

Long-range dependence in volatility is one of the most prominent examples of applications in financial market research involving universal power laws. Its characterization has recently spurred attempts at theoretical explanation of the underlying mechanism. This paper contributes to this recent development by analyzing a simple market fraction asset pricing model with two types of traders---fundamentalists who trade on the price deviation from estimated fundamental value and trend followers who follow a trend which is updated through a geometric learning process. Our analysis shows that the heterogeneity, trend chasing through learning, and the interplay of noisy processes and a stable deterministic equilibrium can be the source of power-law distributed fluctuations. Statistical analysis based on Monte Carlo simulations are conducted to characterize the long memory. Realistic estimates of the power-law decay indices and the (FI)GARCH parameters are presented

Suggested Citation

  • Youwei Li & Xue-Zhong He, 2005. "Long Memory, Heterogeneity, and Trend Chasing," Computing in Economics and Finance 2005 113, Society for Computational Economics.
    • Handle: RePEc:sce:scecf5:113
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    Cited by:

    1. Dieci, Roberto & Foroni, Ilaria & Gardini, Laura & He, Xue-Zhong, 2006. "Market mood, adaptive beliefs and asset price dynamics," Chaos, Solitons & Fractals, Elsevier, vol. 29(3), pages 520-534.
    2. Chiarella, Carl & Iori, Giulia, 2009. "The impact of heterogeneous trading rules on the limit order book and order flows," Journal of Economic Dynamics and Control, Elsevier, vol. 33(3), pages 525-537.
    3. Li, Y. & Donkers, A.C.D. & Melenberg, B., 2006. "The Non- and Semiparametric Analysis of MS Models : Some Applications," Other publications TiSEM c14adc9f-f490-40d6-81b7-8, Tilburg University, School of Economics and Management.

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    Keywords

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    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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