We introduce a model of  financial bubbles with two assets (risky and risk-free), in which rational investors and noise traders co-exist. Rational investors form expectations on the return and risk of a risky asset and maximize their  expected utility with respect to their allocation on the risky asset versus the risk-free asset. Noise traders are subjected to social imitation and follow momentum trading. By contrast to previous models in the field, we do not allow agents to switch between trading strategies. Allowing for random time-varying herding propensity, we are able to reproduce several  stylized facts of financial markets such as a fat-tail distribution of returns , volatility clusteringand transient faster-than-exponential bubble growth with approximate log-periodic behavior  . The model accounts well for the behavior of traders and for the price dynamics that developed during the dotcom bubble in 1995-2000. Momentum strategies are shown to be transiently profitable, supporting these strategies as enhancing herding behavior.
We introduce a model of super-exponential financial bubbles with two assets (risky and risk-free), in which rational investors and noise traders co-exist. Rational investors form expectations on the return and risk of a risky asset and maximize their constant relative risk aversion expected utility with respect to their allocation on the risky asset versus the risk-free asset. Noise traders are subjected to social imitation and follow momentum trading. Allowing for random time-varying herding propensity, we are able to reproduce several well-known stylized facts of financial markets such as a fat-tail distribution of returns and volatility clustering. In particular, we observe transient faster-than-exponential bubble growth with approximate log-periodic behavior and give analytical arguments why this follows from our framework . The model accounts well for the behavior of traders and for the price dynamics that developed during the dotcom bubble in 1995-2000. Momentum strategies are shown to be transiently profitable, supporting these strategies as enhancing herding behavior.
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super-exponential
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constant relative risk aversion
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By contrast to previous models in the field, we do not allow agents to switch between trading strategies.
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well-known
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, volatility clusteringand
and volatility clustering. In particular, we observe
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and give analytical arguments why this follows from our framework