Cross-section instability in financial markets: impatience, extrapolation, and switching

Springer Science and Business Media LLC
Publication Type:
Journal Article
Decisions in Economics and Finance, 2021, 44, (2), pp. 727-754
Issue Date:
Filename Description Size
10.1007 s10203-021-00348-5.pdfPublished version1.42 MB
Adobe PDF
Full metadata record
AbstractThis paper presents a stylized model of interaction among boundedly rational heterogeneous agents in a multi-asset financial market to examine how agents’ impatience, extrapolation, and switching behaviors can affect cross-section market stability. Besides extrapolation and performance based switching between fundamental and extrapolative trading documented in single asset market, we show that a high degree of ‘impatience’ of agents who are ready to switch to more profitable trading strategy in the short run provides a further cross-section destabilizing mechanism. Though the ‘fundamental’ steady-state values, which reflect the standard present-value of the dividends, represent an unbiased equilibrium market outcome in the long run (to a certain extent), the price deviation from the fundamental price in one asset can spill-over to other assets, resulting in cross-section instability. Based on a (Neimark–Sacker) bifurcation analysis, we provide explicit conditions on how agents’ impatience, extrapolation, and switching can destabilize the market and result in a variety of short and long-run patterns for the cross-section asset price dynamics.
Please use this identifier to cite or link to this item: