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Heterogeneous Expectations and Speculative Behaviour in a Dynamic Multi-Asset Framework

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Following the framework of a one risky - one riskless asset model developed by Brock and Hommes (1998), this paper considers a discrete-time model of a financial market where heterogeneous groups of agents allocate their wealth amongst multiple risky assets and a riskless asset. Agents follow different expectation formation schemes for both first and second moments of the distribution of returns. Instead of using a Walrasian auctioneer scenario as the market clearing mechanism, a market maker scenario is used. In particular, the paper focuses on the case of two risky assets and two agent types, fundamentalists and trend chasers. Conditions for the stability of the “fundamental” equilibrium are established in terms of the key parameters, in particular the extrapolation rate of the trend chasers and the weight of the two groups in the market. Numerical explorations are performed in order to analyze the combined effect of the interaction between heterogeneous traders and the diversification among multiple risky assets. Particular attention is paid to the effect of the correlation between the risky assets. It turns out that investors’ anticipated correlation and portfolio diversification do not always have a stabilizing role, but rather may act as a further source of complexity in the financial market.

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File URL: http://www.qfrc.uts.edu.au/research/research_papers/rp166.pdf
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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 166.

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Length: 26 pages
Date of creation: 01 Sep 2005
Publication status: Published as: Chiarella, C., Dieci, R. and He, X., 2007, "Heterogeneous Expectations and Speculative Behaviour in a Dynamic Multi-Asset Framework", Journal of Economic Behavior and Organization, 62(3), 408-427.
Handle: RePEc:uts:rpaper:166
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  1. Day, Richard H. & Huang, Weihong, 1990. "Bulls, bears and market sheep," Journal of Economic Behavior & Organization, Elsevier, vol. 14(3), pages 299-329, December.
  2. Westerhoff, Frank H., 2004. "Multiasset Market Dynamics," Macroeconomic Dynamics, Cambridge University Press, vol. 8(05), pages 596-616, November.
  3. C. H. Hommes, 2001. "Financial markets as nonlinear adaptive evolutionary systems," Quantitative Finance, Taylor & Francis Journals, vol. 1(1), pages 149-167.
  4. Bohm, Volker & Wenzelburger, Jan, 2005. "On the performance of efficient portfolios," Journal of Economic Dynamics and Control, Elsevier, vol. 29(4), pages 721-740, April.
  5. Chiarella, Carl & He, Xue-Zhong, 2002. "Heterogeneous Beliefs, Risk and Learning in a Simple Asset Pricing Model," Computational Economics, Springer;Society for Computational Economics, vol. 19(1), pages 95-132, February.
  6. Jianping Mei & Hsien-Hsing Liao (ed.), 2003. "Asset Pricing," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 4647, January.
  7. William A. Brock & Cars H. Hommes, 1997. "A Rational Route to Randomness," Econometrica, Econometric Society, vol. 65(5), pages 1059-1096, September.
  8. Chiarella, Carl & He, Xue-Zhong, 2003. "Heterogeneous Beliefs, Risk, And Learning In A Simple Asset-Pricing Model With A Market Maker," Macroeconomic Dynamics, Cambridge University Press, vol. 7(04), pages 503-536, September.
  9. Chiarella, Carl & Dieci, Roberto & Gardini, Laura, 2002. "Speculative behaviour and complex asset price dynamics: a global analysis," Journal of Economic Behavior & Organization, Elsevier, vol. 49(2), pages 173-197, October.
  10. Brock, William A. & Hommes, Cars H., 1998. "Heterogeneous beliefs and routes to chaos in a simple asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 22(8-9), pages 1235-1274, August.
  11. Fernando Fernandez-Rodriguez & Maria-Dolores Garcia-Artiles & Juan Manuel Martin-Gonzalez, 2002. "A model of speculative behaviour with a strange attractor," Applied Mathematical Finance, Taylor & Francis Journals, vol. 9(3), pages 143-161.
  12. Lux, Thomas, 1998. "The socio-economic dynamics of speculative markets: interacting agents, chaos, and the fat tails of return distributions," Journal of Economic Behavior & Organization, Elsevier, vol. 33(2), pages 143-165, January.
  13. Volker Böhm & Carl Chiarella, 2005. "Mean Variance Preferences, Expectations Formation, And The Dynamics Of Random Asset Prices," Mathematical Finance, Wiley Blackwell, vol. 15(1), pages 61-97.
  14. Beja, Avraham & Goldman, M Barry, 1980. " On the Dynamic Behavior of Prices in Disequilibrium," Journal of Finance, American Finance Association, vol. 35(2), pages 235-248, May.
  15. Xue-Zhong He, 2003. "Asset Pricing, Volatility and Market Behaviour: A Market Fraction Approach," Research Paper Series 95, Quantitative Finance Research Centre, University of Technology, Sydney.
  16. Carl Chiarella & Roberto Dieci & Laura Gardini, 2005. "The Dynamic Interaction of Speculation and Diversification," Applied Mathematical Finance, Taylor & Francis Journals, vol. 12(1), pages 17-52.
  17. Gaunersdorfer, Andrea, 2000. "Endogenous fluctuations in a simple asset pricing model with heterogeneous agents," Journal of Economic Dynamics and Control, Elsevier, vol. 24(5-7), pages 799-831, June.
  18. Wenzelburger, Jan, 2004. "Learning to predict rationally when beliefs are heterogeneous," Journal of Economic Dynamics and Control, Elsevier, vol. 28(10), pages 2075-2104, September.
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