Heterogeneous expectations in asset pricing: Empirical evidence from the S&P500

This paper empirically assesses heterogeneous expectations in asset pricing. We use a maximum likelihood approach on S&P500 data to estimate a structural model. Our empirical results are consistent with a market populated with fundamentalists and chartists. In addition, agents switch between these groups conditional on their previous performance. The results imply that the model can explain the inflation and deflation of bubbles. Finally, the model is shown to be in the deterministically stable region, but produces stochastic bubbles of similar length and magnitude as empirically observed.

[1]  Xue-Zhong He,et al.  Power-law behaviour, heterogeneity, and trend chasing , 2007 .

[2]  Carl Chiarella,et al.  Heterogeneity, Market Mechanisms, and Asset Price Dynamics , 2008 .

[3]  Maureen O'Hara,et al.  Market Microstructure Theory , 1995 .

[4]  Saangjoon Baak.  Tests for bounded rationality with a linear dynamic model distorted by heterogeneous expectations , 1999 .

[5]  C. Chiarella,et al.  HETEROGENEOUS BELIEFS, RISK, AND LEARNING IN A SIMPLE ASSET-PRICING MODEL WITH A MARKET MAKER , 2003, Macroeconomic Dynamics.

[6]  Robert J. Vigfusson.  Switching between Chartists and Fundamentalists: A Markov Regime-Switching Approach , 1996 .

[7]  I. Tonks,et al.  Trading Rules and Excess Volatility , 1992, Journal of Financial and Quantitative Analysis.

[8]  Sebastiano Manzan,et al.  Behavioral Heterogeneity in Stock Prices , 2005 .

[9]  C. Hommes.  Heterogeneous Agent Models in Economics and Finance , 2005 .

[10]  William A. Brock,et al.  A rational route to randomness , 1997 .

[11]  Investor Response to Suggested Criteria for the Selection of Mutual Funds , 1982 .

[12]  Xue-Zhong He,et al.  Heterogeneity, convergence, and autocorrelations , 2008 .

[13]  P. Seiler,et al.  Speculative dynamics , 2010 .

[14]  J. Fred Weston,et al.  The Investment, Financing, and Valuation of the Corporation. , 1963 .

[15]  F. Westerhoff,et al.  Nonlinearities and Cyclical Behavior: The Role of Chartists and Fundamentalists , 2003 .

[16]  Carl Chiarella,et al.  Does the market maker stabilize the market , 2009 .

[17]  Remco C. J. Zwinkels,et al.  Heterogeneity of Agents and Exchange Rate Dynamics: Evidence from the EMS , 2006 .

[18]  E. Fama,et al.  The Equity Premium , 2001 .

[19]  Frank Westerhoff,et al.  TECHNICAL ANALYSIS BASED ON PRICE-VOLUME SIGNALS AND THE POWER OF TRADING BREAKS , 2006 .

[20]  Adrian Pagan,et al.  The econometrics of financial markets , 1996 .

[21]  Guofu Zhou,et al.  Technical analysis: An asset allocation perspective on the use of moving averages , 2009 .

[22]  R. Bloomfield,et al.  Predicting the Next Step of a Random Walk: Experimental Evidence of Regime-Shifting Beliefs , 2002 .

[23]  Carl Chiarella,et al.  Heterogeneous Expectations and Speculative Behavior in a Dynamic Multi-Asset Framework , 2005 .

[24]  J. Lintner.  The Aggregation of Investor's Diverse Judgments and Preferences in Purely Competitive Security Markets , 1969, Journal of Financial and Quantitative Analysis.

[25]  T. Lux,et al.  Estimation of Agent-Based Models: The Case of an Asymmetric Herding Model , 2005 .

[26]  H. Simon,et al.  A Behavioral Model of Rational Choice , 1955 .

[27]  James F. Nieberding.  Estimating Overcharges in Antitrust Cases Using a Reduced-Form Approach: Methods and Issues , 2006 .

[28]  Laurens Swinkels,et al.  The Economic Value of Fundamental and Technical Information in Emerging Currency Markets , 2007 .

[29]  F. Westerhoff,et al.  Structural stochastic volatility in asset pricing dynamics: Estimation and model contest , 2012 .

[31]  Remco C. J. Zwinkels,et al.  Behavioural Heterogeneity and Shift-Contagion: Evidence from the Asian Crisis , 2008 .

[32]  Peter Winker,et al.  A global optimization heuristic for estimating agent based models , 2003, Comput. Stat. Data Anal..

[33]  Christine X. Jiang,et al.  Stock market volatility, excess returns, and the role of investor sentiment , 2002 .

[34]  J. Chavas.  On information and market dynamics: The case of the U.S. beef market , 2000 .

[35]  Joep Sonnemans,et al.  Coordination of Expectations in Asset Pricing Experiments , 2003 .

[36]  B. LeBaron,et al.  Simple Technical Trading Rules and the Stochastic Properties of Stock Returns , 1992 .

[37]  R. Franke.  Applying the method of simulated moments to estimate a small agent-based asset pricing model☆ , 2009 .

[39]  T. Teräsvirta.  Specification, Estimation, and Evaluation of Smooth Transition Autoregressive Models , 1994 .

[40]  R. Thaler,et al.  Chapter 18 A survey of behavioral finance , 2003 .

[41]  Nicholas Barberis,et al.  A Model of Investor Sentiment , 1997 .

[42]  Kenneth A. Froot,et al.  Chartists, Fundamentalists and the Demand for Dollars , 1991 .

[43]  M. Marchesi,et al.  Scaling and criticality in a stochastic multi-agent model of a financial market , 1999, Nature.

[44]  Carl Chiarella,et al.  The dynamics of speculative behaviour , 1992, Ann. Oper. Res..

[45]  Charles F. Manski,et al.  Alternative Estimators and Sample Designs for Discrete Choice Analysis , 1981 .

[46]  Remco C. J. Zwinkels,et al.  Carry trade and foreign exchange rate puzzles , 2013 .

[47]  L. Summers,et al.  Noise Trader Risk in Financial Markets , 1990, Journal of Political Economy.

[48]  Frank Westerhoff,et al.  Commodity price cycles and heterogeneous speculators: a STAR–GARCH model , 2007 .

[49]  W. BrownGregory,et al.  Volatility, Sentiment, and Noise Traders , 1999 .

[50]  Stefan Reitz,et al.  Heterogeneous expectations in the foreign exchange market , 2005 .

[51]  S. Johansen.  Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models , 1991 .

[52]  Jeffrey Hales,et al.  Predicting the Next Step of a Random Walk: Experimental Evidence of Regime-Shifting Beliefs , 2001 .

[53]  E. C. Zeeman,et al.  On the unstable behaviour of stock exchanges , 1974 .

[54]  Kenneth A. Froot,et al.  Chartists, Fundamentalists, and Trading in the Foreign Exchange Market , 1989 .

[55]  Sebastiano Manzan,et al.  Heterogeneous Expectations, Exchange Rate Dynamics and Predictability , 2007 .

[56]  T. Lux.  The socio-economic dynamics of speculative markets: interacting agents, chaos, and the fat tails of return distributions , 1998 .

[57]  Carl Chiarella,et al.  A Dynamical Analysis of Moving Average Rules , 2006 .

[58]  B. LeBaron.  Agent-based Computational Finance , 2006 .

[59]  R. Thaler,et al.  A Survey of Behavioral Finance , 2002 .

[60]  Paul De Grauwe,et al.  Exchange rate puzzles: A tale of switching attractors , 2006 .

[61]  A. Tversky,et al.  Judgment under Uncertainty: Heuristics and Biases , 1974, Science.

[62]  Richard H. Day,et al.  Bulls, bears and market sheep , 1990 .

[63]  W. Brock,et al.  Heterogeneous beliefs and routes to chaos in a simple asset pricing model , 1998 .