Abstract
In this article, we introduce local interaction in a pure exchange economy where the endowment process follows a simple hidden Markov chain and risk-averse agents have incomplete information about the regime. We show that the interplay between internal, external local and external global effects (a) can account for different temporal behavior of the price-dividend ratio, (b) can reproduce some stylized facts of price changes and (c) suggest that market efficiency in the sense of return predictability may be inversely related to the information precision.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Preview
Unable to display preview. Download preview PDF.
References
K. Back. Incomplete and asymmetric information in asset pricing theory. In M. Frittelli and W. Runggaldier, editors, Stochastic Methods in Finance, Springer Lecture Notes in Mathematics 856. Springer, 2004.
R. T. Baillie. Long memory processes and fractional integration in econometrics. Journal of Econometrics, 73:5-59, 1996.
S. Bikhchandani, D. Hirshleifer, and I. Welch. A theory of fads, fashion, custom, and cultural change as informational cascades. Journal of Political Economy, 100(5):992-1026, 1992.
M. Brennan and Y. Xia. Stock price volatility and equity premium. Journal of Monetary Economics, 47:249-283, 2001.
J. H. Cochrane. Asset Pricing. Princeton University Press, Princeton, 2nd edition, 2005.
R. Cont and J.-P. Bouchaud. Herd behavior and aggregate fluctuations in financial markets. Macroeconomic Dynamics, 4(2), 2000.
J. B. Detemple. Asset pricing in a production economy with incomplete information. Journal of Finance, XLI(2):383-391, 1986.
M. U. Dothan and D. Feldman. Equilibrium interest rates and multiperiod bonds in a partially observable economy. Journal of Finance, XLI(2):369-382, 1986.
J. D. Farmer and S. Joshi. The price dynamics of common trading strategies. Journal of Economic Behavior & Organization, 49(2):149-171, 2002.
G. Gennotte. Optimal portfolio choice under incomplete information. Journal of Finance, XLI(3): 733-749, 1986.
P. Gopikrishnan, V. Plerou, Y. Liu, N. L. A. Amaral, X. Gabaix, and H. E. Stanley. Scaling and correlation in financial time series. Physica A, 287:362-373, 2000.
J. D. Hamilton. Regime-switching models. In S. N. Durlauf and L. E. Blume, editors, The New Palgrave Dictionary of Economics. Palgrave Macmillan, 2008.
D. Hirshleifer and T. Shumway. Good day sunshine: Stock returns and the weather. Journal of Finance, 58(3):1009-1032, 2003.
C. H. Hommes. Interacting agents in finance. In L. E. Blume and S. N. Durlauf, editors, New Palgrave Dictionary of Economics. Palgrave Macmillan, 2nd edition, 2006.
A. Kirman. Whom or what does the representative individual represent? Journal of Economic Perspectives, 6(2):117-136, 1992.
B. LeBaron. Agent-based computational finance. In K. L. Judd and L. Tesfatsion, editors, Agentbased computational economics, volume 2 of The Handbook of Computational Economics. North-Holland, Amsterdam, 2006.
R. E. Jr. Lucas. Asset prices in an exchange economy. Econometrica, 46(6):1429-1445, 1978.
T. Lux and M. Marchesi. Scaling and criticality in a stochastic multi-agent model of a financial market. Nature, 397:498-500, 1999.
R. Mehra and E. C. Prescott. The equity premium in retrospect. In G. M. Constantinides, M. Harris, and R. M. Stulz, editors, Handbook of the Economics of Finance: Financial Markets and Asset Pricing, volume 1B of Handbooks in Economics. North-Holland, Amsterdam, 2003.
R. Mehra and E. C. Prescott. The equity premium: A puzzle. Journal of Monetary Economics, 15: 145-161, 1985.
S. Morris. Contagion. Review of Economic Studies, 67:57-78, 2000.
A. Orlean. Bayesian interactions and collective dynamics of opinion: Herd behavior and mimetic contagion. Journal of Economic Behavior & Organization, 28:257-274, 1995.
E. M. Jr. Saunders. Stock prices and wall street weather. American Economic Review, 83:1337-1345,1993.
D. Stauffer and D. Sornette. Self-organized percolation model for stock market fluctuations. Physica A, 271:496-506, 1999.
P. Veronesi. How does information quality affect stock returns? Journal of Finance, LV(2):807-837,2000.
P. Veronesi. Stock market overreaction to bad news in good times: A rational expectations equilibrium model. The Review of Financial Studies, 12(5):975-1007, 1999.
N. J. Vriend. Ace models of endogenous interactions. In K. L. Judd and L. Tesfatsion, editors, Agent-based computational economics, volume 2 of The Handbook of Computational Economics. North-Holland, Amsterdam, 2006.
A. W. Wilhite. Economic activity on fixed networks. In K. L. Judd and L. Tesfatsion, editors, Agentbased computational economics, volume 2 of The Handbook of Computational Economics. North-Holland, Amsterdam, 2006.
S. Wolfram. A new kind of science. Wolfram Media, Champaign, 2002.
Author information
Authors and Affiliations
Editor information
Editors and Affiliations
Rights and permissions
Copyright information
© 2008 Springer-Verlag Berlin Heidelberg
About this chapter
Cite this chapter
Hule, R., Lawrenz, J. (2008). Local Interaction, Incomplete Information and Properties of Asset Prices. In: Schredelseker, K., Hauser, F. (eds) Complexity and Artificial Markets. Lecture Notes in Economics and Mathematical Systems, vol 614. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-540-70556-7_8
Download citation
DOI: https://doi.org/10.1007/978-3-540-70556-7_8
Publisher Name: Springer, Berlin, Heidelberg
Print ISBN: 978-3-540-70553-6
Online ISBN: 978-3-540-70556-7
eBook Packages: Business and EconomicsEconomics and Finance (R0)