Abstract
This paper presents a stylized model of interaction among boundedly rational heterogeneous agents in a multi-asset financial market to examine how agents’ impatience, extrapolation, and switching behaviors can affect cross-section market stability. Besides extrapolation and performance based switching between fundamental and extrapolative trading documented in single asset market, we show that a high degree of ‘impatience’ of agents who are ready to switch to more profitable trading strategy in the short run provides a further cross-section destabilizing mechanism. Though the ‘fundamental’ steady-state values, which reflect the standard present-value of the dividends, represent an unbiased equilibrium market outcome in the long run (to a certain extent), the price deviation from the fundamental price in one asset can spill-over to other assets, resulting in cross-section instability. Based on a (Neimark–Sacker) bifurcation analysis, we provide explicit conditions on how agents’ impatience, extrapolation, and switching can destabilize the market and result in a variety of short and long-run patterns for the cross-section asset price dynamics.
Highlights
A well-established strand of research on financial market dynamics emphasizes the impact of behavioral heterogeneity on market stability in an evolutionary framework, in which asset prices, investors’ beliefs, and trading strategies coevolve over time, via ‘expectations feedback’ processes
5 Conclusion In this paper, we introduce a stylized dynamic model of a multi-asset financial market in the presence of investors with heterogeneous expectations and having some degree of ‘impatience’ to provide insight into the potentially destabilizing effect of various behavioral forces in financial markets and the complex way it can bring about cross-section instabilities
The dynamics of asset prices is driven by disequilibrium adjustments as a consequence of excess demand/supply of myopic mean-variance investors with different types of beliefs about future price developments
Summary
A well-established strand of research on financial market dynamics emphasizes the impact of behavioral heterogeneity on market stability in an evolutionary framework, in which asset prices, investors’ beliefs, and trading strategies coevolve over time, via ‘expectations feedback’ processes (see, e.g., Hommes 2013 and the recent survey Dieci and He 2018). Besides generalizing the basic framework developed by Dieci et al (2006) directly, the model is close in spirit to Palczewski et al (2016) where, in an evolutionary finance framework, investors can shift (only part of) their funds between competing portfolio managers with different investment styles, and the total amount of freely flowing capital is treated as an exogenous parameter, broadly corresponding to the proportion 1 − n f − nc of impatient short-term speculators in our setup.4 It follows that the actual shares of each group in time period t are given by: qtf = n f + (1 − n f − nc)htf , qtc.
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
