dorsal/arxiv
View SchemaImpact of Investor's Varying Risk Aversion on the Dynamics of Asset Price Fluctuations
| Authors | Baosheng Yuan, Kan Chen |
|---|---|
| Categories | |
| ArXiv ID | physics/0506224 |
| URL | https://arxiv.org/abs/physics/0506224 |
Abstract
While the investors' responses to price changes and their price forecasts are well accepted major factors contributing to large price fluctuations in financial markets, our study shows that investors' heterogeneous and dynamic risk aversion (DRA) preferences may play a more critical role in the dynamics of asset price fluctuations. We propose and study a model of an artificial stock market consisting of heterogeneous agents with DRA, and we find that DRA is the main driving force for excess price fluctuations and the associated volatility clustering. We employ a popular power utility function, $U(c,\gamma)=\frac{c^{1-\gamma}-1}{1-\gamma}$ with agent specific and time-dependent risk aversion index, $\gamma_i(t)$, and we derive an approximate formula for the demand function and aggregate price setting equation. The dynamics of each agent's risk aversion index, $\gamma_i(t)$ (i=1,2,...,N), is modeled by a bounded random walk with a constant variance $\delta^2$. We show numerically that our model reproduces most of the ``stylized'' facts observed in the real data, suggesting that dynamic risk aversion is a key mechanism for the emergence of these stylized facts.
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"abstract": "While the investors\u0027 responses to price changes and their price forecasts are\nwell accepted major factors contributing to large price fluctuations in\nfinancial markets, our study shows that investors\u0027 heterogeneous and dynamic\nrisk aversion (DRA) preferences may play a more critical role in the dynamics\nof asset price fluctuations. We propose and study a model of an artificial\nstock market consisting of heterogeneous agents with DRA, and we find that DRA\nis the main driving force for excess price fluctuations and the associated\nvolatility clustering. We employ a popular power utility function,\n$U(c,\\gamma)=\\frac{c^{1-\\gamma}-1}{1-\\gamma}$ with agent specific and\ntime-dependent risk aversion index, $\\gamma_i(t)$, and we derive an approximate\nformula for the demand function and aggregate price setting equation. The\ndynamics of each agent\u0027s risk aversion index, $\\gamma_i(t)$ (i=1,2,...,N), is\nmodeled by a bounded random walk with a constant variance $\\delta^2$. We show\nnumerically that our model reproduces most of the ``stylized\u0027\u0027 facts observed\nin the real data, suggesting that dynamic risk aversion is a key mechanism for\nthe emergence of these stylized facts.",
"arxiv_id": "physics/0506224",
"authors": [
"Baosheng Yuan",
"Kan Chen"
],
"categories": [
"physics.soc-ph",
"physics.comp-ph",
"q-fin.ST"
],
"title": "Impact of Investor\u0027s Varying Risk Aversion on the Dynamics of Asset Price Fluctuations",
"url": "https://arxiv.org/abs/physics/0506224"
},
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