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Long Memory, Heterogeneity and Trend Chasing

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 found.

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File URL: http://www.qfrc.uts.edu.au/research/research_papers/rp148.pdf
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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 148.

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Length: 32 pages
Date of creation: 01 Jan 2005
Date of revision:
Handle: RePEc:uts:rpaper:148
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