Behavioural Finance and Financial Economics with Heterogeneous Beliefs

Abstract

The literature about the dynamics of prices in speculative markets, based on the interaction of boundedly rational heterogeneous agents has become well developed in recent decades. Hommes CH [1] provides an excellent survey work on Heterogeneous Agent Models (HAMs) in economics and finance. In this strand of literature, one is able to generate sophisticated structures that capture some of the dynamics and stylized facts documented in financial time series at the macro level by aggregating the simple interactions of boundedly rational agents using various trading rules at the micro level. Such stylized facts include excess volatility, high trading volume, temporary bubbles and trend following, sudden crashes and mean reversion, clustered volatility and fat tails in the returns distribution. These models generally include nonlinear elements which may come from agents’ or demand functions, evolutionary switching between available strategies, and contagion and consequent transition of speculators among optimistic and pessimistic groups.