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Super-Exponential Endogenous Bubbles in an Equilibrium Model of Fundamentalist and Chartist Traders

44 Pages Posted: 8 Feb 2015 Last revised: 10 Mar 2015

Taisei Kaizoji

International Christian University

Matthias Leiss

ETH Zurich

Alexander I. Saichev

ETH Zurich - D-MTEC (Deceased)

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute

Date Written: February 3, 2015

Abstract

We introduce a model of super-exponential financial bubbles with two assets (risky and risk-free), in which fundamentalist and chartist traders co-exist. Fundamentalists form expectations on the return and risk of a risky asset and maximize their constant relative risk aversion expected utility with respect to their allocation on the risky asset versus the risk-free asset. Chartists are subjected to social imitation and follow momentum trading. Allowing for random time-varying herding propensity, we are able to reproduce several well-known stylized facts of financial markets such as a fat-tail distribution of returns and volatility clustering. In particular, we observe transient faster-than-exponential bubble growth with approximate log-periodic behavior and give analytical arguments why this follows from our framework. The model accounts well for the behavior of traders and for the price dynamics that developed during the dotcom bubble in 1995-2000. Momentum strategies are shown to be transiently profitable, supporting these strategies as enhancing herding behavior.

Keywords: financial bubbles, faster-than-exponential growth, social imitation, momentum trading, chartists dotcom bubble

JEL Classification: C73, G01, G17

Suggested Citation

Kaizoji, Taisei and Leiss, Matthias and Saichev, Alexander I. and Sornette, Didier, Super-Exponential Endogenous Bubbles in an Equilibrium Model of Fundamentalist and Chartist Traders (February 3, 2015). Swiss Finance Institute Research Paper No. 15-07. Available at SSRN: https://ssrn.com/abstract=2561719 or http://dx.doi.org/10.2139/ssrn.2561719

Taisei Kaizoji

International Christian University ( email )

Osawa 3-10-2
Mitaka-shi
Tokyo, Mitaka-shi 181-8585
Japan
81-422-33-3367 (Phone)
81-422-33-3367 (Fax)

HOME PAGE: http://subsite.icu.ac.jp/people/kaizoji/

Matthias Leiss

ETH Zurich ( email )

Rämistrasse 101
ZUE F7
Zürich, 8092
Switzerland

Alexander Saichev

ETH Zurich - D-MTEC (Deceased)

Didier Sornette (Contact Author)

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
Switzerland
41446328917 (Phone)
41446321914 (Fax)

HOME PAGE: http://www.er.ethz.ch/

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

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