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Microfounding GARCH Models and Beyond: A Kyle-inspired Model with Adaptive Agents

Author

Listed:
  • Michele Vodret
  • Iacopo Mastromatteo
  • Bence Tóth
  • Michael Benzaquen

    (LadHyX - Laboratoire d'hydrodynamique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris - CNRS - Centre National de la Recherche Scientifique)

Abstract

We relax the strong rationality assumption for the agents in the paradigmatic Kyle model of price formation, thereby reconciling the framework of asymmetrically informed traders with the Adaptive Market Hypothesis, where agents use inductive rather than deductive reasoning. Building on these ideas, we propose a stylised model able to account parsimoniously for a rich phenomenology, ranging from excess volatility to volatility clustering. While characterising the excess-volatility dynamics, we provide a microfoundation for GARCH models. Volatility clustering is shown to be related to the self-excited dynamics induced by traders' behaviour, and does not rely on clustered fundamental innovations. Finally, we propose an extension to account for the fragile dynamics exhibited by real markets during flash crashes.

Suggested Citation

  • Michele Vodret & Iacopo Mastromatteo & Bence Tóth & Michael Benzaquen, 2023. "Microfounding GARCH Models and Beyond: A Kyle-inspired Model with Adaptive Agents," Post-Print hal-03797251, HAL.
    • Handle: RePEc:hal:journl:hal-03797251
    Note: View the original document on HAL open archive server: https://hal.science/hal-03797251
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    References listed on IDEAS

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    1. Robert J. Shiller, 2014. "Speculative Asset Prices," American Economic Review, American Economic Association, vol. 104(6), pages 1486-1517, June.
    2. Bouchaud,Jean-Philippe & Potters,Marc, 2003. "Theory of Financial Risk and Derivative Pricing," Cambridge Books, Cambridge University Press, number 9780521819169, October.
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    Keywords

    adaptive agents; volatility clustering; excess volatility; price impact;
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