Asset Pricing Under Endogenous Expectation in an Artificial Stock Market
We propose a theory of asset pricing based on heterogeneous agents who continually adapt their expectations to the market that these expectations aggregatively create. And we explore the implications of this theory computationally using our Santa Fe artificial stock market. Asset markets, we argue, have a recursive nature in that agents' expectations are formed on the basis of their anticipations of other agents' expectations, which precludes expectations being formed by deductive means. Instead traders continually hypothesize---continually explore---expectational models, buy or sell on the basis of those that perform best, and confirm or discard these according to their performance. Thus individual beliefs or expectations become endogenous to the market, and constantly compete within an ecology of others' beliefs or expectations. The ecology of beliefs coevolves over time. Computer experiments with this endogenous-expectations market explain one of the more striking puzzles in finance: that market traders often believe in such concepts as technical trading, "market psychology," and bandwagon effects, while academic theorists believe in market efficiency and a lack of speculative opportunities. Both views, we show, are correct, but within different regimes. Within a regime where investors explore alternative expectational models at a low rate, the market settles into the rational-expectations equilibrium of the efficient-market literature. Within a regime where the rate of exploration of alternative expectations is higher, the market self-organizes into a complex pattern. It acquires a rich psychology, technical trading emerges, temporary bubbles and crashes occur, and asset prices and trading volume show statistical features---in particular, GARCH behavior---characteristic of actual market data.
To our knowledge, this item is not available for
download. To find whether it is available, there are three
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
|Date of creation:||Dec 1996|
|Contact details of provider:|| Postal: 1399 Hyde Park Road, Santa Fe, New Mexico 87501|
Web page: http://www.santafe.edu/sfi/publications/working-papers.html
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Marengo, Luigi & Tordjman, Helene, 1996. "Speculation, Heterogeneity and Learning: A Simulation Model of Exchange Rates Dynamics," Kyklos, Wiley Blackwell, vol. 49(3), pages 407-438.
- E.R. Grannan & G.H. Swindle, 1994. "Contrarians and Volatility Clustering," Working Papers 94-03-010, Santa Fe Institute.
- Shleifer, Andrei & Summers, Lawrence H, 1990. "The Noise Trader Approach to Finance," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 19-33, Spring.
- Shiller, Robert J, 1981.
"Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?,"
American Economic Review,
American Economic Association, vol. 71(3), pages 421-436, June.
- Robert J. Shiller, 1980. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," NBER Working Papers 0456, National Bureau of Economic Research, Inc.
- Friedman, Daniel & Aoki, Masanao, 1992. "Inefficient Information Aggregation as a," Bulletin of Economic Research, Wiley Blackwell, vol. 44(4), pages 251-279, October.
- Martin Shubik, 1996.
"Time and Money,"
96-03-013, Santa Fe Institute.
- Brock, W. & Lakonishok, J. & Lebaron, B., 1991.
"Simple Technical Trading Rules And The Stochastic Properties Of Stock Returns,"
90-22, Wisconsin Madison - Social Systems.
- Brock, William & Lakonishok, Josef & LeBaron, Blake, 1992. " Simple Technical Trading Rules and the Stochastic Properties of Stock Returns," Journal of Finance, American Finance Association, vol. 47(5), pages 1731-1764, December.
- Andrew W. Lo & A. Craig MacKinlay, 1987.
"Stock Market Prices Do Not Follow Random Walks: Evidence From a Simple Specification Test,"
NBER Working Papers
2168, National Bureau of Economic Research, Inc.
- Andrew W. Lo, A. Craig MacKinlay, 1988. "Stock Market Prices do not Follow Random Walks: Evidence from a Simple Specification Test," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 41-66.
- Blume, Lawrence & Easley, David, 1992. "Evolution and market behavior," Journal of Economic Theory, Elsevier, vol. 58(1), pages 9-40, October.
- Blume, Lawrence E. & Easley, David, 1982. "Learning to be rational," Journal of Economic Theory, Elsevier, vol. 26(2), pages 340-351, April.
- David H. Cutler & James M. Poterba & Lawrence H. Summers, 1988.
"What Moves Stock Prices?,"
487, Massachusetts Institute of Technology (MIT), Department of Economics.
- Brock, W.A. & Hommes, C.H., 1997. "Models of Compelxity in Economics and Finance," Working papers 9706, Wisconsin Madison - Social Systems.
- Milgrom, Paul & Stokey, Nancy, 1982.
"Information, trade and common knowledge,"
Journal of Economic Theory,
Elsevier, vol. 26(1), pages 17-27, February.
- Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 5-59.
- Bossaerts, Peter, 1995. "The Econometrics of Learning in Financial Markets," Econometric Theory, Cambridge University Press, vol. 11(01), pages 151-189, February.
- repec:cup:etheor:v:11:y:1995:i:1:p:151-89 is not listed on IDEAS
- Michael Youssefmir & Bernardo A. Huberman, 1995. "Clustered Volatility in Multiagent Dynamics," Working Papers 95-05-051, Santa Fe Institute.
- Summers, Lawrence H, 1986. " Does the Stock Market Rationally Reflect Fundamental Values?," Journal of Finance, American Finance Association, vol. 41(3), pages 591-601, July.
- W. Brian Arthur, 1992. "On Learning and Adaptation in the Economy," Working Papers 854, Queen's University, Department of Economics.
- Sanford J Grossman & Joseph E Stiglitz, 1997.
"On the Impossibility of Informationally Efficient Markets,"
Levine's Working Paper Archive
1908, David K. Levine.
- Grossman, Sanford J & Stiglitz, Joseph E, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, American Economic Association, vol. 70(3), pages 393-408, June.
- Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
- Frankel, Jeffrey A & Froot, Kenneth A, 1990. "Chartists, Fundamentalists, and Trading in the Foreign Exchange Market," American Economic Review, American Economic Association, vol. 80(2), pages 181-185, May.
- Diba, Behzad T & Grossman, Herschel I, 1988. "The Theory of Rational Bubbles in Stock Prices," Economic Journal, Royal Economic Society, vol. 98(392), pages 746-754, September.
When requesting a correction, please mention this item's handle: RePEc:wop:safiwp:96-12-093. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Thomas Krichel)
If references are entirely missing, you can add them using this form.