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Breeds of risk-adjusted fundamentalist strategies in an order- driven market

  • Marco LiCalzi

    (Dept. of Applied Mathematics - University Ca' Foscari Venice)

  • Paolo Pellizzari

    (Dept. of Applied Mathematics - University Ca' Foscari Venice)

This paper studies an order-driven stock market where agents have heterogeneous estimates of the fundamental value of the risky asset. The agents are budget-constrained and follow a value-based trading strategy which buys or sells depending on whether the price of the asset is below or above its risk-adjusted fundamental value. This environment generates returns that are remarkably leptokurtic and fat-tailed. By extending the study over a grid of different parameters for the fundamentalist trading strategy, we exhibit the existence of monotone relationships between the bid-ask spread demanded by the agents and several statistics of the returns. We conjecture that this effect, coupled with positive dependence of the risk premium on the volatility, generates positive feedbacks that might explain volatility bursts.

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Paper provided by EconWPA in its series Computational Economics with number 0506001.

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Length: 17 pages
Date of creation: 08 Jun 2005
Date of revision:
Handle: RePEc:wpa:wuwpco:0506001
Note: Type of Document - pdf; pages: 17
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  1. Farmer, J. Doyne & Joshi, Shareen, 2002. "The price dynamics of common trading strategies," Journal of Economic Behavior & Organization, Elsevier, vol. 49(2), pages 149-171, October.
  2. Marco LiCalzi & Paolo Pellizzari, 2002. "Fundamentalists Clashing over the Book: A Study of Order-Driven Stock Markets," Computational Economics 0207001, EconWPA, revised 04 Mar 2003.
  3. P. Bak & M. Paczuski & M. Shubik, 1996. "Price Variations in a Stock Market with Many Agents," Working Papers 96-09-075, Santa Fe Institute.
  4. Giulia Iori, 2000. "A microsimulation of traders activity in the stock market: the role of heterogeneity, agents' interactions and trade frictions," Finance 0004007, EconWPA.
  5. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  6. Maslov, Sergei, 2000. "Simple model of a limit order-driven market," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 278(3), pages 571-578.
  7. Carl Chiarella & Giulia Iori, 2002. "A simulation analysis of the microstructure of double auction markets," Quantitative Finance, Taylor & Francis Journals, vol. 2(5), pages 346-353.
  8. Jean-Philippe Bouchaud & Marc Mezard & Marc Potters, 2002. "Statistical properties of stock order books: empirical results and models," Quantitative Finance, Taylor & Francis Journals, vol. 2(4), pages 251-256.
  9. Matassini, Lorenzo & Franci, Fabio, 2001. "On financial markets trading," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 289(3), pages 526-542.
  10. Jean-Philippe Bouchaud & Marc Mezard & Marc Potters, 2002. "Statistical properties of stock order books: empirical results and models," Science & Finance (CFM) working paper archive 0203511, Science & Finance, Capital Fund Management.
  11. Bottazzi, Giulio & Dosi, Giovanni & Rebesco, Igor, 2005. "Institutional architectures and behavioral ecologies in the dynamics of financial markets," Journal of Mathematical Economics, Elsevier, vol. 41(1-2), pages 197-228, February.
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