Limit Distribution of Evolving Strategies in Financial Markets

Research Paper Number: 294, Quantitative Finance Research Centre, University of Technology, Sydney

28 Pages Posted: 23 Oct 2012

See all articles by Carl Chiarella

Carl Chiarella

University of Technology, Sydney - UTS Business School, Finance Discipline Group

Corrado Di Guilmi

University of Technology Sydney (UTS) - UTS Business School

Date Written: August 1, 2011

Abstract

In this paper we model a financial market composed of agents with heterogeneous beliefs who change their strategy over time. We propose two different solution methods which lead to two different types of endogenous dynamics. The first makes use of the maximum entropy approach to obtain an exponential type probability function for strategies, analogous to the well known Brock and Hommes (1997) model, but with the endogenous specification for the intensity of choice parameter, which varies over time as a consequence of the relative performances of each strategy. The second type of dynamics is obtained by setting up a master equation and solving it using recently developed asymptotic solution techniques, which yield a system of differential equations describing the evolution of the share of each strategy in the market. The performance of the two solutions are then compared and contrasted with the empirical evidence.

Suggested Citation

Chiarella, Carl and Di Guilmi, Corrado, Limit Distribution of Evolving Strategies in Financial Markets (August 1, 2011). Research Paper Number: 294, Quantitative Finance Research Centre, University of Technology, Sydney, Available at SSRN: https://ssrn.com/abstract=2165610 or http://dx.doi.org/10.2139/ssrn.2165610

Carl Chiarella (Contact Author)

University of Technology, Sydney - UTS Business School, Finance Discipline Group ( email )

PO Box 123
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HOME PAGE: http://www.business.uts.edu.au/finance/

Corrado Di Guilmi

University of Technology Sydney (UTS) - UTS Business School ( email )

Sydney
Australia

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