Co-existence of Trend and Value in Financial Markets: Estimating an Extended Chiarella Model

TL;DR

This paper extends the Chiarella model to include noise traders and non-linear demand, using Bayesian calibration to analyze the co-existence of trend and value effects in financial markets across history.

Contribution

It introduces an extended HABM that captures the interaction of trend and value, calibrated on historical data without external pricing models.

Findings

Reproduces empirical non-monotonic relation between past trends and future returns

Shows trend-followers can cause market mispricings to become bimodal

Demonstrates the model's ability to reflect long-term over- and under-valuation

Abstract

Trend and Value are pervasive anomalies, common to all financial markets. We address the problem of their co-existence and interaction within the framework of Heterogeneous Agent Based Models (HABM). More specifically, we extend the Chiarella (1992) model by adding noise traders and a non-linear demand of fundamentalists. We use Bayesian filtering techniques to calibrate the model on time series of prices across a variety of asset classes since 1800. The fundamental value is an output of the calibration, and does not require the use of an external pricing model. Our extended model reproduces many empirical observations, including the non-monotonic relation between past trends and future returns. The destabilizing activity of trend-followers leads to a qualitative change of mispricing distribution, from unimodal to bimodal, meaning that some markets tend to be over- (or under-) valued for long periods of time.