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Long Memory, Heterogeneity and Trend Chasing

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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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  • Xue-Zhong He & Youwei Li, 2005. "Long Memory, Heterogeneity and Trend Chasing," Research Paper Series 148, Quantitative Finance Research Centre, University of Technology, Sydney.
    • Handle: RePEc:uts:rpaper:148
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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. 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.
    3. 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.

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    More about this item

    Keywords

    asset pricing; fundamentalists and trend followers; market fraction; stability; learning; long memory;
    All these keywords.

    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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