On the Stability of Equilibrium in Markets with Heterogeneous Investment Horizons

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This study incorporates the difference in agents’ trading intervals into the heterogeneous agent model developed by Brock and Hommes (1998). We show that the effect of a longer investment horizon appears as either an increase or a decrease in the fraction of strategy adopted by long-term traders, depending on the values of the risk-free rate in the economy and the variance perceived by traders. Specifically, when long-term traders are fundamentalists and short-term traders are trend followers, we examine whether an increase in the intensity of choice to switch predictors can lead to market instability, which is the main result obtained by Brock and Hommes (1998). This is robust if costs borne by short-term traders are less than those borne by long-term traders. Furthermore, when there is no cost borne by short-term traders who conduct twice as many transactions as long-term traders, the short-term traders’ belief form for establishing the stability of the fundamental steady state becomes more restrictive. This happens if and only if the ratio of variance in the long-term investment horizon to that in the short-term investment horizon is larger than the risk-free rate in the economy.