Asset price and wealth dynamics in a financial market with heterogeneous agents

• Published in: Journal of economic dynamics & control 2006-09, Vol.30 (9), p.1755-1786
• Main Authors: Chiarella, Carl, Dieci, Roberto, Gardini, Laura
• Format: Article
• Language: English
• Subjects: Agents; Asset valuation; Assets; Capital market; Coexisting attractors; Economic dynamics; Expected utility; Financial market dynamics; Heterogeneous agents; Securities markets; Studies; Wealth; Wealth dynamics
• ISSN: 0165-1889; 1879-1743
• DOI: 10.1016/j.jedc.2005.10.011

This paper considers a discrete-time model of a financial market with one risky asset and one risk-free asset, where the asset price and wealth dynamics are determined by the interaction of two groups of agents, fundamentalists and chartists. In each period each group allocates its wealth between the risky asset and the safe asset according to myopic expected utility maximization, but the two groups have heterogeneous beliefs about the price change over the next period: the chartists are trend extrapolators, while the fundamentalists expect that the price will return to the fundamental. We assume that investors’ optimal demand for the risky asset depends on wealth, as a result of CRRA utility. A market maker is assumed to adjust the market price at the end of each trading period, based on excess demand and on changes of the underlying reference price. The model results in a nonlinear discrete-time dynamical system, with growing price and wealth processes, but it is reduced to a stationary system in terms of asset returns and wealth shares of the two groups. It is shown that the long-run market dynamics are highly dependent on the parameters which characterize agents’ behaviour as well as on the initial condition. Moreover, for wide ranges of the parameters a (locally) stable fundamental steady state coexists with a stable ‘non-fundamental’ steady state, or with a stable closed orbit, where only chartists survive in the long run: such cases require the numerical and graphical investigation of the basins of attraction. Other dynamic scenarios include periodic orbits and more complex attractors, where in general both types of agents survive in the long run, with time-varying wealth fractions.