Trading, Price Setting and Volatility in Equity Markets Under Divergent Expectations and Adaptive Valuations

36 Pages Posted: 31 Aug 2006  

Jacob Paroush

Bar-Ilan University - Department of Economics

Robert A. Schwartz

Baruch College - CUNY

Avner Wolf

Baruch College

Date Written: August 2006

Abstract

For a market to be viable, participants must be heterogeneous. Traditional asymmetric information models achieve this by including informed, uninformed, and noise traders. We model heterogeneity differently by relaxing the assumption that identically informed agents form homogeneous expectations. Adaptive valuations follow as agents can change their assessments when the order flow reveals the valuations of others. We use simulation to illustrate the major findings of our model - path dependency, convergence to multiple equilibria, and an intra-day volatility structure. The analysis has implications for volatility surges following public as well as non-public information release, and for longer-run herding, bubbles, and crashes.

Keywords: Trading, price discovery, volatility, equity markets, divergent expectations, adaptive valuations, and market structure

JEL Classification: G10

Suggested Citation

Paroush, Jacob and Schwartz, Robert A. and Wolf, Avner, Trading, Price Setting and Volatility in Equity Markets Under Divergent Expectations and Adaptive Valuations (August 2006). Available at SSRN: https://ssrn.com/abstract=927500 or http://dx.doi.org/10.2139/ssrn.927500

Jacob Paroush

Bar-Ilan University - Department of Economics ( email )

Ramat-Gan, 52900
Israel
+972.3.531.8569 (Phone)
+972.3.535.3180 (Fax)

Robert A. Schwartz

Baruch College - CUNY ( email )

Zicklin School of Business
17 Lexington Avenue
New York, NY 10010
United States
646-312-3467 (Phone)
646-312-3530 (Fax)

Avner Wolf (Contact Author)

Baruch College ( email )

One Bernard Baruch Way
New York, NY 10010
United States

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