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Financial markets with heterogeneous agents as nonlinear news filters

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  • Cees Diks

Abstract

This paper aims at increasing our insights into the way financial markets respond to news. We view the market as a (nonlinear) filter of news on fundamentals. A stylized version of this situation is obtained by considering by a time dependent dividend rate which is driving the market. To model this, we take as a starting point a market model of the CBS (Continuous Beliefs Dynamics) type developed by Diks and Van der Weide (2003). The model is adapted in such a way that the dividend rate is no longer required to be constant, but, for example, might follow a geometric Brownian motion. Already for model parameters for which the price tends to a stable equilibrium price under a constant dividend rate, this modification leads to complicated stochastic dynamics. Simulations show that the price responses to shocks on the dividend rate can become highly nonlinear and persistent, as a result of triggering the endogenous noise process of the CBS. In a simulation study we found that this type of nonlinear response to news can generate many typical properties of asset prices, such as volatility clustering, fat-tailed return distributions, and persistence of deviations from fundamental prices.

Suggested Citation

  • Cees Diks, 2005. "Financial markets with heterogeneous agents as nonlinear news filters," Computing in Economics and Finance 2005 290, Society for Computational Economics.
    • Handle: RePEc:sce:scecf5:290
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    More about this item

    Keywords

    Heterogeneous agents; Financial markets; Continuous BeliefsSystems; Nonlinear Response; News Induced Endogenous Noise;
    All these keywords.

    JEL classification:

    • C00 - Mathematical and Quantitative Methods - - General - - - General
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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