Abstract:
The use of various moving average (MA) rules remains popular with financial market
practitioners. These rules have recently become the focus of a number empirical studies, but
there have been very few studies of financial market models where some agents employ
technical trading rules of the type used in practice. In this paper, we propose a dynamic
financial market model in which demand for traded assets has both a fundamentalist and a
chartist component. The chartist demand is governedby the difference between current price
and a (long-run) MA. Both types of traders are boundedly rational in the sense that, based on
a fitness measure such as realized capital gains,traders switch from a strategy with low fitness
to the one with high fitness. We characterize the stability and bifurcation properties of
the underlying deterministic model via the reaction coefficient of the fundamentalists, the
extrapolation rate of the chartists and the lag length used for the MA. By increasing the
intensity of choice to switching strategies. We then examine various rational routes to
randomness for different MA rules.The price dynamics of the MA rule are also examined and
one of our main findings is that an increase of the window length of the MA rule can destabilize an otherwise stable system, leading to more complicated,even chaotic behaviour.
The analysis of the corresponding stochastic model is able to explain various market price
phenomena,including temporary bubbles, sudden market crashes,price resistance and price
switching between different levels.
