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Wealth Dynamics and a Bias Toward Momentum Trading

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  • Blake LeBaron

    (International Business School, Brandeis University)

Abstract

Evolutionary metaphors have been prominent in both economics and finance. They are often used as basic foundations for rational behavior and efficient markets. Theoretically, a mechanism which selects for rational investors actually requires many caveats, and is far from generic. This paper tests wealth based evolution in a simple, stylized agent-based financial market. The setup borrows extensively from current research in finance that considers optimal behavior with some amount of return predictability. The results confirm that with a homogeneous world of log utility investors wealth will converge onto optimal adaptive forecasting parameters. However, in the case of utility functions which differ from log, wealth selection alone converges to parameters which are economically far from the optimal forecast parameters. This serves as a strong reminder that wealth selection and utility maximization are not the same thing. Therefore, suboptimal financial forecasting strategies may be difficult to drive out of a market, and may even do quite well for some time.

Suggested Citation

  • Blake LeBaron, 2010. "Wealth Dynamics and a Bias Toward Momentum Trading," Working Papers 14, Brandeis University, Department of Economics and International Business School.
    • Handle: RePEc:brd:wpaper:14
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    File URL: http://www.brandeis.edu/economics/RePEc/brd/doc/Brandeis_WP14.pdf
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    References listed on IDEAS

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    Cited by:

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    2. Butt, Hilal Anwar & Virk, Nader Shahzad, 2017. "Momentum profits and time varying illiquidity effect," Finance Research Letters, Elsevier, vol. 20(C), pages 253-259.

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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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