Heterogeneous Expectations and Speculative Behavior in a Dynamic Multi-Asset Framework

Quantitative Finance Research Center Working Paper No. 166

26 Pages Posted: 11 Apr 2006

See all articles by Carl Chiarella

Carl Chiarella

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

Roberto Dieci

Department of Mathematics, University of Bologna

Xuezhong He

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

Date Written: September 2005

Abstract

Following the framework of a one risky - one riskless asset model developed by Brock and Hommes (1998), this paper considers a discrete-time model of a financial market where heterogeneous groups of agents allocate their wealth amongst multiple risky assets and a riskless asset. Agents follow different expectation formation schemes for both first and second moments of the distribution of returns. Instead of using a Walrasian auctioneer scenario as the market clearing mechanism, a market maker scenario is used. In particular, the paper focuses on the case of two risky assets and two agent types, fundamentalists and trend chasers. Conditions for the stability of the "fundamental" equilibrium are established in terms of the key parameters, in particular the extrapolation rate of the trend chasers and the weight of the two groups in the market. Numerical explorations are performed in order to analyze the combined effect of the interaction between heterogeneous traders and the diversification among multiple risky assets. Particular attention is paid to the effect of the correlation between the risky assets. It turns out that investors' anticipated correlation and portfolio diversification do not always have a stabilizing role, but rather may act as a further source of complexity in the financial market.

Keywords: heterogeneous beliefs, asset pricing, portfolio choice, bifurcation analysis, comovements in stock prices

JEL Classification: C61, D84, G11, G12

Suggested Citation

Chiarella, Carl and Dieci, Roberto and He, Xue-Zhong 'Tony', Heterogeneous Expectations and Speculative Behavior in a Dynamic Multi-Asset Framework (September 2005). Quantitative Finance Research Center Working Paper No. 166, Available at SSRN: https://ssrn.com/abstract=893086 or http://dx.doi.org/10.2139/ssrn.893086

Carl Chiarella (Contact Author)

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

PO Box 123
Broadway, NSW 2007
Australia
+61 2 9514 7719 (Phone)
+61 2 9514 7711 (Fax)

HOME PAGE: http://www.business.uts.edu.au/finance/

Roberto Dieci

Department of Mathematics, University of Bologna ( email )

Piazza di Porta San Donato, 5
Bologna, I-40126
Italy

HOME PAGE: http://www.unibo.it/Faculty/default.aspx?UPN=roberto.dieci%40unibo.it

Xue-Zhong 'Tony' He

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

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