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Long Memory, Heterogeneity and Trend Chasing

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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 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
Handle: RePEc:uts:rpaper:148
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Keywords: asset pricing; fundamentalists and trend followers; market fraction; stability; learning; long memory;

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Find related papers by JEL classification:
  • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: 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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Cited by:

  1. 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.
  2. Roberto Dieci & Ilaria Foroni & Laura Gardini & Xue-Zhong He, 2005. "Market Mood, Adaptive Beliefs and Asset Price Dynamics," Research Paper Series 162, Quantitative Finance Research Centre, University of Technology, Sydney.

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