A Classical Model of Speculative Asset Price Dynamics

TL;DR

This paper develops a classical model of speculative asset prices, explaining stylized facts like fat tails, volatility clustering, and bubbles through collective bargaining and trader memory, supported by experimental validation.

Contribution

It introduces a classical, reservation-price-based model of speculation that explains key stylized facts and bubble phenomena in asset markets, validated through experimental tests.

Findings

Fat tails arise from amplifying speculation effects.

Volatility clustering results from traders' long memory of news.

Bubbles persist and grow with more speculators and shorter trading horizons.

Abstract

In retrospect, the experimental findings on competitive market behavior called for a revival of the old, classical, view of competition as a collective higgling and bargaining process (as opposed to price-taking behaviors) founded on reservation prices (in place of the utility function). In this paper, we specialize the classical methodology to deal with speculation, an important impediment to price stability. The model involves typical features of a field or lab asset market setup and lends itself to an experimental test of its specific predictions; here we use the model to explain three general stylized facts, well established both empirically and experimentally: the excess, fat-tailed, and clustered volatility of speculative asset prices. The fat tails emerge in the model from the amplifying nature of speculation, leading to a random-coefficient autoregressive return process (and power-law tails); the volatility clustering is due to the traders' long memory of news; bubbles are a persistent phenomenon in the model, and, assuming the standard lab present value pattern, the bubble size increases with the proportion of speculators and decreases with the trading horizon.