Behavioral Asset Pricing Model Research Articles

A behavioral asset pricing model with a time-varying second moment

We develop a simple behavioral asset pricing model with fundamentalists and chartists in order to study price behavior in financial markets when chartists estimate both conditional mean and variance by using a weighted averaging process. Through a stability, bifurcation, and normal form analysis, the market impact of the weighting process and time-varying second moment are examined. It is found that the fundamental price becomes stable (unstable) when the activities from both types of traders are balanced (unbalanced). When the fundamental price becomes unstable, the weighting process leads to different price dynamics, depending on whether the chartists act as either trend followers or contrarians. It is also found that a time-varying second moment of the chartists does not change the stability of the fundamental price, but it does influence the stability of the bifurcations. The bifurcation becomes stable (unstable) when the chartists are more (less) concerned about the market risk characterized by the time-varying second moment. Different routes to complicated price dynamics are also observed. The analysis provides an analytical foundation for the statistical analysis of the corresponding stochastic version of this type of behavioral model.

Comment on: Are behavioral asset-pricing models structural?

According to Stanley Zin, financial economists on both sides of the behavioral finance debate have failed to ask the right questions. To Zin, the most important question we should ask about behavioral models is whether they make accurate predictions. Structural models at least have prediction as their goal, whether or not they achieve it. Implicit in this view is the notion that structural models somehow ‘‘explain what is going on’’, that they can offer insights into why economic phenomena occur. In most other fields of science, evaluating a structural model would not be a matter of debate. Because the goal of a structural model is prediction, the model would be evaluated directly using a controlled experiment. If in finance we could somehow change the parameters of our economy, or at least statistically detect such a change, we would also have a direct test of a structural model. The former is clearly impossible; the latter, Zin argues, is unreliable. The question of how to evaluate a structural model without experiments is clearly a difficult one. Instead of attempting an answer, Zin argues that two commonly used criteria are wrong. One of these criteria, that a model appear realistic, looks good at first glance. But, quoting Friedman and Lucas, Zin argues that we are not trying for

Are behavioral asset-pricing models structural?

The recent increase in interest in so-called behavioral models of asset-pricing is motivated partly by the desire to have models that appear realistic in light of experimental evidence, and partly by their success in moment-matching exercises. This paper argues that the attention given to these two criteria misses perhaps the most important aspect of the modeling exercises. That is, the search for parameters that are invariant to changes in the economic environment. It is precisely this invariance that motivates the use of a tightly parameterized general equilibrium model. Assessing a model on this dimension is difficult and, as the paper argues through the use of suggestive examples, will undoubtedly require strong subjective judgments about the reasonableness of preference assumptions. Such judgments are routinely made about the reasonableness of assumptions about stochastic endowments. The paper suggests that more effort be applied to understanding aggregation in these models and to the exploration of behavioral assumptions in a less flexible but less corruptible time-stationary recursive class of preferences.