Heterogeneous beliefs, risk, and learning in a simple asset-pricing model with a market maker

Abstract

This paper studies the dynamics of a simple discounted present-value asset-pricing model where agents have different risk attitudes and follow different expectation formation schemes for the price distribution. A market-maker scenario is used as the market-clearing mechanism, in contrast to the more usual Walrasian scenario. In particular, the paper concentrates on models of fundamentalists and trend followers who follow recursive geometric-decay (learning) processes (GDP) with both finite and infinite memory. The analysis depicts how the dynamics are affected by various key elements (or parameters) of the model, such as the adjustment speed of the market maker, the extrapolation rate of the trend followers, the decay rate of the GDP, the lag length used in the learning GDP, and external random factors.