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On the distribution of stock-market returns - Implications of Evolutionary Finance

  • Stefan Reimann
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    Risk management and asset pricing benefit from simple functional descriptions of the distribution of real asset returns. Recently, several authors have proposed that asset returns in real stock markets are distributed according to a hyperbolic distribution. While asset returns are generated by trades over time, the natural question is: What does economic theory imply concerning return distributions? We propose a simple model of price formation and, thus, return distribution which is based on economic reasoning. The markets behavior is represented by a pair consisting of a time-constant strategy and a dynamical trading strategy generating a flow between funds. Simulations of the price dynamics generate returns with fat-tail behavior in line with that of a hyperbolic distribution.

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    File URL: http://www.iew.uzh.ch/wp/iewwp232.pdf
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    Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 232.

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    Handle: RePEc:zur:iewwpx:232
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    1. AMIR, Rabah & EVSTIGNEEV, Igor & HENS, Thorsten & SCHENK-HOPPÉ, Klaus Reiner, 2003. "Market selection and survival of investment strategies," CORE Discussion Papers 2003099, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    2. 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.
    3. R. Cont, 2001. "Empirical properties of asset returns: stylized facts and statistical issues," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 223-236.
    4. Igor V. Evstigneev & Thorsten Hens & Klaus Reiner Schenk-Hoppé, 2002. "Market Selection Of Financial Trading Strategies: Global Stability," Mathematical Finance, Wiley Blackwell, vol. 12(4), pages 329-339.
    5. Blume, Lawrence & Easley, David, 1992. "Evolution and market behavior," Journal of Economic Theory, Elsevier, vol. 58(1), pages 9-40, October.
    6. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
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