A Nonlinear Structural Model for Volatility Clustering
University of Vienna, Deparment of Finance
Cars H. Hommes
University of Amsterdam - Amsterdam School of Economics (ASE)
September 1, 2000
EFA 0623; SFB Working Paper 63; Univ. of Vienna & Vienna Univ. of Economics & Business Admin. & CeNDEF Working Paper; Univ. of Amsterdam
A simple nonlinear structural model of endogenous belief heterogeneity is proposed. News about fundamentals is an IID random process, but nevertheless volatility clustering occurs as an endogenous phenomenon caused by the interaction between different types of traders, fundamentalists and technical analysts. The belief types are driven by an adaptive, evolutionary dynamics according to the success of the prediction strategies in the recent past conditioned upon price deviations from the rational expectations fundamental price. Asset prices switch irregularly between two different regimes - close to the fundamental price fluctuations with low volatility, and periods of persistent deviations from fundamentals where the market is dominated by technical trading - thus, creating time varying volatility similar to that observed in real financial data.
Number of Pages in PDF File: 21
JEL Classification: G12, D84, E32working papers series
Date posted: October 23, 2000
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