Speculative bubbles and crashes: Fundamentalists and positive-feedback trading
Authored by Po-Keng Cheng, Young Shin Kim
Date Published: 2017
DOI: 10.1080/23322039.2017.1381370
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Abstract
In this paper, we develop and examine a simple interactive agent-based
model, where the distribution of returns generated from the model takes
into account two stylized facts about financial markets: fat tails and
volatility clustering. Our results indicate that the risk tolerance of
fundamentalists and the relative funding rate of positive-feedback
traders vs. fundamentalists are key factors determining the path of
price fluctuations. Fundamentalists are more able to dominate the market
when they are more willing than positive-feedback traders to take risks.
In addition, more crises occur as positive-feedback traders face higher
funding costs compared to fundamentalists. Our model suggests that
fundamentalists cause heavier tails, and positive-feedback traders cause
the formation of speculative bubbles. Our model also indicates that
traders' attitudes toward risk vary across time and market. The
generally low level of risk bearing by fundamentalists could explain the
frequent occurrence of bubbles.
Tags
Dynamics
fat tails
noise
Equity premium
Stock-market
Financial-markets
Traders
Asset markets
Noise traders
Positive-feedback traders
Fundamentalists
Rational
bubbles
Speculative bubbles
Wealth effect
Heavy tails
Clustered volatility
Kolmogorov-smirnov