We model a market populated by two groups of boundedly rational agents: “newswatchers” and “momentum traders.” Each newswatcher observes some private information, but fails to extract other newswatchers’ information from prices. If information diffuses gradually across the population, prices underreact in the short run. The underreaction means that the momentum traders can profit by trendchasing. However, if they can only implement simple (i.e., univariate) strategies, their attempts at arbitrage must inevitably lead to overreaction at long horizons. In addition to providing a unified account of under- and overreactions, the model generates several other distinctive implications.

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Since Friedman (1953), an advantage often attributed to flexible exchange rate regimes over fixed regimes is their ability to insulate more effectively the economy against real shocks. I use a post-Bretton Woods sample (1973-96) of seventy-five developing countries to assess whether the responses of real GDP, real exchange rates, and prices to terms-of-trade shocks differ systematically across exchange rate regimes. I find that responses are significantly different across regimes in a way that supports Friedman’s hypothesis. The paper also examines the importance of terms-of-trade shocks in explaining the overall variance of output and prices in developing countries.

A simple asset pricing model with two types of adaptively learning traders, fundamentalists and technical analysts, is studied. Fractions of these trader types, which are both boundedly rational, change over time according to evolutionary learning, with technical analysts conditioning their forecasting rule upon deviations from a benchmark fundamental. Volatility clustering arises endogenously in this model. Two mechanisms are proposed as an explanation. The first is coexistence of a stable steady state and a stable limit cycle, which arise as a consequence of a so-called Chenciner bifurcation of the system. The second is intermittency and associated bifurcation routes to strange attractors. Both phenomena are persistent and occur generically. Simple economic intuition why these phenomena arise in nonlinear multi-agent evolutionary systems is provided.

We document the equity trading practices of approximately 1,200 institutions from the third quarter of 1987 through the third quarter of 1995. We decompose trading by institutions into the initiation of new positions (entry), the termination of previous positions (exit), and adjustments to ongoing holdings. Institutions act as momentum traders when they enter stocks but as contrarian traders when they exit or make adjustments to ongoing holdings. We find significant differences in trading practices among different types of institutions. In a celebrated article published almost a half century ago, Friedman (1953) argues that rational speculation must stabilize asset prices. More recently, DeLong, Shleifer, Summers and Waldmann (DSSW, 1990) show that momentum traders (also referred to as trend chasers or positive feedback traders) can in fact destabilize stock prices and thereby threaten the efficiency of financial markets. DSSW’s proof has inspired numerous empirical investigations that focus almost exclusively on the behavior of institutional investors. There are at least two reasons for this focus. First, a large fraction of corporate equity is held by institutional investors; institutional ownership of shares in U.S. firms increased from approximately seven percent in

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Empirical facts from financial data pose some of the most difficult puzzles for equilibrium macroeco-nomic modeling. Features such as volatility, excess kurtosis, and conditional heteroscedasticity are not easily replicated by any single representative agent model. Most agent-based financial markets are able to match a good subset of these features quite easily. This paper will summarize some of the results from an agent-based model. It will be argued that agent-based approaches also make more sense economically then their representative agent competition. They will also be compared and contrasted with approaches coming from the behavioral finance perspective as well.