Volatility Clustering: A Nonlinear Theoretical Approach

45 Pages Posted: 21 Nov 2015 Last revised: 2 Aug 2016

See all articles by Xuezhong He

Xuezhong He

University of Technology Sydney (UTS) - Finance Discipline Group, Business School; Financial Research Network (FIRN)

Kai Li

Macquarie Business School, Macquarie University

Chuncheng Wang

Harbin Institute of Technology

Date Written: July 22, 2016

Abstract

This paper verifies the endogenous mechanism and economic intuition on volatility clustering using the coexistence of two locally stable attractors proposed by Gaunersdorfer, Hommes and Wagener (2008). By considering a simple asset pricing model with two types of boundedly rational traders, fundamentalists and trend followers, and noise traders, we provide conditions on the coexistence of locally stable steady state and invariant cycle of the underlying nonlinear deterministic financial market model and show numerically that the interaction of the coexistence of the deterministic dynamics and noise processes can endogenously generate volatility clustering and long range dependence in volatility observed in financial markets. Economically, volatility clustering occurs when neither the fundamental nor trend following traders dominate the market and when traders switch more often between the two strategies.

Keywords: Volatility clustering, fundamentalists and trend followers, bounded rationality, stability, coexisting attractors.

JEL Classification: D84, E32, G12

Suggested Citation

He, Xue-Zhong 'Tony' and Li, Kai and Wang, Chuncheng, Volatility Clustering: A Nonlinear Theoretical Approach (July 22, 2016). Available at SSRN: https://ssrn.com/abstract=2694097 or http://dx.doi.org/10.2139/ssrn.2694097

Xue-Zhong 'Tony' He (Contact Author)

University of Technology Sydney (UTS) - Finance Discipline Group, Business School ( email )

Haymarket
Sydney, NSW 2007
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Kai Li

Macquarie Business School, Macquarie University ( email )

Level 6 4 Eastern Road, Macquarie University
North Ryde NSW 2109
Sydney, NSW 99999
Australia
435473800 (Phone)

Chuncheng Wang

Harbin Institute of Technology ( email )

92 West Dazhi Street
Nan Gang District
Harbin, heilongjiang 150001
China

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