Heterogeneity, Selection, and Wealth Dynamics (original) (raw)

Wealth Selection in a Financial Market with Heterogeneous Agents

2007

We study the co-evolution of asset prices and agents' wealth in a financial market populated by an arbitrary number of heterogeneous, boundedly rational, investors. We model assets' demand to be proportional to agents' wealth, so that wealth dynamics can be used as a selection device. For a general class of investment behaviors, we are able to characterize the long run market outcome, i.e. the steady-state equilibrium values of asset return, and agents' survival. Our investigation illustrates that market forces pose certain limits on the outcome of agents' interactions even within the "wilderness of bounded rationality". As an application we show that our analysis provides a rigorous explanation for the results of the simulation model introduced in Levy, Levy, and Solomon (1994).

Wealth-driven Selection in a Financial Market with Heterogeneous Agents

2009

We study the co-evolution of asset prices and individual wealth in a financial market populated by an arbitrary number of heterogeneous, boundedly rational agents. Using wealth dynamics as a selection device we are able to characterize the long run market outcomes, i.e. asset returns and wealth distributions, for a general class of investment behaviors. Our investigation illustrates that market interaction and wealth dynamics pose certain limits on the outcome of agents' interactions even within the "wilderness of bounded rationality". As an application we consider the case of heterogeneous meanvariance optimizers and provide insights into the results of the simulation model introduced by Levy, Levy and Solomon (1994).

If You're so Smart, why Aren't You Rich? Belief Selection in Complete and Incomplete Markets

Econometrica, 2006

This paper provides an analysis of the asymptotic properties of Pareto optimal consumption allocations in a stochastic general equilibrium model with heterogeneous consumers. In particular we investigate the market selection hypothesis, that markets favor traders with more accurate beliefs. We show that in any Pareto optimal allocation whether each consumer vanishes or survives is determined entirely by discount factors and beliefs. Since equilibrium allocations in economies with complete markets are Pareto optimal, our results characterize the limit behavior of these economies. We show that, all else equal, the market selects for consumers who use Bayesian learning with the truth in the support of their prior and selects among Bayesians according to the size of their parameter space. Finally, we show that in economies with incomplete markets these conclusions may not hold. With incomplete markets payoff functions can matter for long run survival, and the market selection hypothesis fails.

If You\u27re So Smart, Why Aren\u27t You Rich?Belief Selection in Complete and Incomplete Markets

2001

This paper provides an analysis of the asymptotic properties of consumption allocations in a stochastic general equilibrium model with heterogeneous consumers. In particular we investigate the market selection hypothesis, that markets favor traders with more accurate beliefs. We show that in any Pareto optimal allocation whether each consumer vanishes or survives is determined entirely by discount factors and beliefs. Since equilibrium allocations in economies with complete markets are Pareto optimal, our results characterize the limit behavior of these economies. We show that, all else equal, the market selects for consumers who use Bayesian learning with the truth in the support of their prior and selects among Bayesians according to the size of the their parameter space. Finally, we show that in economies with incomplete markets these conclusions may not hold. Payoff functions can matter for long run survival, and the market selection hypothesis fails

Market Selection and Asset Pricing for the Handbook of Financial Markets : Dynamics and Evolution

2008

In this chapter we survey asset pricing in dynamic economies with heterogeneous, rational traders. By ‘rational’ we mean traders whose decisions can be described by preference maximization, where preferences are restricted to those which have an subjective expected utility (SEU) representation. By ’heterogeneous” we mean SEU traders with different and distinct payoff functions, discount factors and beliefs about future prices which are not necessarily correct. We examine whether the market favors traders with particular characteristics through the redistribution of wealth, and the implications of wealth redistribution for asset pricing. The arguments we discuss on the issues of market selection and asset pricing in this somewhat limited domain have a broader applicability. We discuss selection dynamics on Gilboa-Schmeidler preferences and on arbitrarily specified investment and savings rules to see what discipline, if any, the market wealth-redistribution dynamic brings to this envi...

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

Journal of Economic Dynamics and Control, 2006

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 longrun 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

Heterogeneous beliefs, wealth accumulation, and asset price dynamics

Journal of Economic Dynamics and Control, 1996

seminar audience at UCSD for their helpful comments. Abstract A model of asset markets with two types of investors is developed and its dynamic properties are analyzed. "Optimists" expect on average higher returns on the risky assets than "pesaimists" do. The stochastic procesa íor equilibrium asset return changes over time as the distribution oí wealth between the two types oí investors changes. In the long run, the share oí wealth held by one type oí investor may become negligible, but it is a180 poesible íor both types to co-exist, depending on the parameter values of the model. Relations between this model and sorne econometric models with time varying parameters, such as the ARCH (Autoregresaive Conditional Heteroskedasticity) model and the STAR (Smooth Transition Autoregresaive) model, are examined. The dynamic properties oí another model, regarding investors who use strategies that are a bit more complex, are al80 analyzed. "Fundamentalists" believe that the asset returns íollow a procesa that is solely determined by íundamentals and "contrarians" assume the market is wrong and choose a portfolio that is exactly opposite of the market portíolio. Again, depending on parameters, both types can co-exist even in the long runo 2

An Asset Pricing Model with Adaptive Heterogeneous Agents and Wealth Effects

Lecture Notes in Economics and Mathematical Systems, 2005

HelQuts.edu.au Summary. The characterisation of agents' preferences by decreasing absolute risk aversion (DARA) and constant relative risk aversion (CRRA) are well documented in the literature and also supported in both empirical and experimental studies. This paper considers a financial market with heterogeneous agents having power utility functions, which are the only utility functions displaying both DARA and CRRA. By introducing a population weighted average wealth measure, we develop an adaptive model to characterise asset price dynamics as well as the evolution of population proportions and wealth dynamics. Some numerical simulations are included to illustrate the evolution of the wealth dynamics, market behaviour and market efficiency within the framework of heterogeneous agents.

Financial Markets Equilibrium with Heterogeneous Agents

Social Science Research Network, 2010

This paper presents an equilibrium model in a pure exchange economy when investors have three possible sources of heterogeneity. Investors may differ in their beliefs, in their level of risk aversion, and in their time preference rate. The authors study the impact of investorsÕ heterogeneity on equilibrium properties and, in particular, on the consumption shares, the market price of risk, the riskfree rate, the bond prices at different maturities, the stock price and volatility as well as on the stock's cumulative returns, and optimal portfolio strategies. The authors relate the heterogeneous economy with the family of associated homogeneous economies with only one class of investors. Crosssectional as well as long-run properties are analyzed.