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An Adaptive Model on Asset Pricing and Wealth Dynamics with Heterogeneous Trading Strategies

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Abstract

This paper develops an adaptive model on asset pricing and wealth dynamic of a financial market with heterogeneous agents and examines the profitability of momentum and contrarian trading strategies. In order to characterize asset price, wealth dynamics and rational adaptiveness arising from the interaction of heterogeneous agents with CRRA utility, an adaptive discrete time equilibrium model in terms of return ad wealth proportions (among heterogeneous representative agents) is established. Taking trend followers and contrarians as the main hetergeneous agents in the model, the profitability of momentum and contrarian trading strategies is analyzed. Our results show the capability of the model to characterize some of the existing evidence on many of anomailies observed in financial markets, including the profitability of momentum trading strategies over short time intervals, rational adaptiveness of agents, overconfidence and underreaction, overreaction and herd behavior, excess volatility, and volatility clustering.

Suggested Citation

  • Carl Chiarella & Xue-Zhong He, 2002. "An Adaptive Model on Asset Pricing and Wealth Dynamics with Heterogeneous Trading Strategies," Research Paper Series 84, Quantitative Finance Research Centre, University of Technology, Sydney.
  • Handle: RePEc:uts:rpaper:84
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    File URL: http://www.qfrc.uts.edu.au/research/research_papers/rp84.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    asset pricing; wealth dynamics; hetergeneity; adaptiveness; profitability; momentum trading strategies; contrarian trading strategies;

    JEL classification:

    • C20 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - General

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