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Price discovery in the presence of boundedly rational agents

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  • Karl Ludwig Keiber

Abstract

In this paper we propose a sequential model of security trading which, compared to existing models, is extended along the notions of (Simon, H.A., A behavioral model of rational choice. Quart. J. Econ., 1955, 64, 99-118; Rubinstein, A., Modeling Bounded Rationality, Zeuthen Lecture Book Series, 1998 (MIT Press: Cambridge, MA), and Odean, T., Do investors trade too much? Am. Econ. Rev., 1999, 89(5), 1279-1298) by adding boundedly rational traders. Our results indicate that both momentum and mean-reversion in asset prices can be attributed to the presence of agents who are subject to systematic errors in the process of forecasting the liquidation value of a risky security. The length of the momentum period is inversely related to both the amount of information-based trading in the market and the rate at which asset specific information is learned by boundedly rational agents. Furthermore, the model allows explicitly to establish a link between the component of the bid-ask spread that can be explained by bounded rationality and both momentum and reversal.

Suggested Citation

  • Karl Ludwig Keiber, 2008. "Price discovery in the presence of boundedly rational agents," Quantitative Finance, Taylor & Francis Journals, vol. 8(3), pages 235-249.
    • Handle: RePEc:taf:quantf:v:8:y:2008:i:3:p:235-249
    DOI: 10.1080/14697680601158692
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    References listed on IDEAS

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    Cited by:

    1. Lee, Kangil & Han, Taek-Whan, 2016. "How vulnerable is the emissions market to transaction costs?: An ABMS Approach," Energy Policy, Elsevier, vol. 90(C), pages 273-286.
    2. Samuel E. Vazquez, 2009. "Scale Invariance, Bounded Rationality and Non-Equilibrium Economics," Papers 0902.3840, arXiv.org.

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