News Reaction in Financial Markets within a Behavioral Finance Model with Heterogeneous Agents

18 Pages Posted: 5 Oct 2012 Last revised: 22 Oct 2012

Thomas Fischer

Lund University - School of Economics and Management; Darmstadt University of Technology

Date Written: October 3, 2012

Abstract

This paper presents a Heterogeneous Agent Model of a financial market with chartist and fundamentalist traders that exhibit bounded rationality and short-term thinking to explain the effect of under and overreaction to news. The existence of the Market Maker’s finite price adjustment speed and the presence of risk aversion lead to the fact that prices do not adjust instantaneously to new information. Chartists use moving average rules to make their investment decisions. They can transform an underreaction-only scenario into a market with overreaction. The use of long moving average rules might even make the market unstable. Higher market efficiency (low deviations from fundamental value), on the other hand, is achieved if high rationality and long-term thinking for the agents is assumed.

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Suggested Citation

Fischer, Thomas, News Reaction in Financial Markets within a Behavioral Finance Model with Heterogeneous Agents (October 3, 2012). Algorithmic Finance (2012), 1:2, 123-139. Available at SSRN: https://ssrn.com/abstract=2156211

Thomas Fischer (Contact Author)

Lund University - School of Economics and Management ( email )

Tycho Brahes väg 1,
S-220 07 Lund, 223 63
Sweden

Darmstadt University of Technology ( email )

Darmstadt, Hesse D-64289
Germany

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