Abstract:
This paper develops a dynamic model of a financial market where heterogeneous agents invest among
multiple risky assets and a risk-free asset, under a market maker scenario. Particular attention is paid to the
case of two risky assets and two agent types, fundamentalists and trend chasers, whose beliefs on both first and
second moments of the conditional distribution of returns are based on past observations. Conditions for the
stability of the “fundamental” equilibrium are established and the effect of the correlation between the risky
assets is examined. It turns out that investors’ anticipated correlation and dynamic portfolio diversification
do not always have a stabilizing role, but rather may act as a source of complexity in the financial market.
