Chapters
Chiarella, C., Kang, B., Meyer, G. & Ziogas, A. 2014, 'Computational methods for derivatives with early exercise features' in Schmedders, K. & Judd, K.L. (eds), Handbook of Computational Economics, Elsevier, Netherlands, pp. 225-275.
Bohm, V., Chiarella, C., He, X. & Huls, T. 2013, 'A homoclinic route to volatility: Dynamics of asset prices under autoregressive forecasting' in Bischi, G.I., Chiarella, C. & Sushko, I. (eds), Global analysis of dynamic models in economics and finance: Essays in honour of Laura Gardini, Springer, Germany, pp. 289-316.
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The article investigates the impact of mean-reverting forecasts in a model of asset pricing with two groups of investors under market clearing. Fundamentalists believe that asset prices follow an exogenous stochastic process, while chartists assume that asset prices follow a stochastic geometric decay process. For high values of mean reversion a period-doubling bifurcation occurs followed by a Neimark-Sacker bifurcation, after which homoclinic points exist inducing chaotic dynamics. Before the occurrence of homoclinic points, all orbits induce significant fluctuations with recurring symmetries and nonvanishing autocorrelations in all time series of prices and returns. After the homoclinic bifurcation, prices and returns follow alternating phases with low fluctuations near the steady state followed by phases with large excursions from the steady state. This shows that nonlinearities of the deterministic model rather than random perturbations are the causes of volatility clustering and of the generation of fat tails. Autocorrelations of prices and returns vanish while those of absolute returns and squared returns persist for high-order lags. Thus, the model is able to reproduce some important empirical market features
Chiarella, C., Huang, N. & Chi-Fai Lo, E. 2013, 'Credit portfolio correlations with dynamic leverage ratios' in Rsch, D. & Scheule, H. (eds), Credit Securitisations and Derivatives: Challenges for the Global Markets, Wiley, Australia, pp. 71-94.
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This chapter extends the dynamic leverage ratio model of of Hui et al. to the two-firm case so as to study the implications for default correlations and joint survival probabilities. The two-firm model has been proposed by Zhou, who extends the one-firm model of Black and Cox to the two-firm situation. The chapter reviews the techniques used by the authors to solve the first-passage-time problem: the method of images and the time varying barrier technique for dealing with time-dependent parameters. The chapter presents the numerical results for the impact on joint survival probabilities and default correlations across a range of different scenarios, for example, different correlation levels, drift rates, volatilities and initial leverage ratios
Chiarella, C. & Di Guilmi, C. 2013, 'A reconsideration of the formal Minskyan analysis: Microfoundations, endogenous money and the public sector' in Bischi, G.I., Chiarella, C. & Sushko, I. (eds), Global analysis of dynamic models in economics and finance: Essays in honour of Laura Gardini, Springer, Germany, pp. 63-81.
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The paper presents a survey of the literature that has grown out of the work of Hyman Minsky and, in particular, of the main models which have mathematically formalised the cyclical dynamics of a capitalist economy implied by the Financial Instability Hypothesis. We identify some of the issues that the existing literature has left unsolved. We then briefly summarise the contributions by Chiarella and Di Guilmi (J Econ Dyn Control 35(8):11511171, 2011c) and (Stud Nonl Dyn Econom forthcoming, 2012), highlighting how these papers have addressed the open questions and how they could be further developed.
Chiarella, C., Flaschel, P. & Semmler, W. 2013, 'Keynes, the dynamic stochastic general equilibrium model, and the business cycle' in Ryuzo Kuroki (ed), Keynes and Modern Economics, Routledge, New York, USA, pp. 85-116.
Keynes in his General Theory has extensively responded to and criticized the classical economics that was dominant at his time. This paper elaborates on how Keynes would have responded to the dynamic stochastic general equilibrium (DSGE) model, or its more popular version, the real business cycle model, that appears to dominate macroeconomics today. Recently also many New Keynesians have employed this new paradigm in macroeconomics. We will discuss some major macroeconomic issues and show how differences in traditional Keynesian and the DSGE models may arise.4 We will also pursue a further more detailed study of why certain Keynesian ideas can usefully be applied to modem macroeconomics. This will help to resolve some important puzzles of modem macroeconomic theory.
Cheang, G.H. & Chiarella, C. 2012, 'A modern view on Merton's jump-diffusion model' in Cohen, S.N., Madan, D., Siu, T.K. & Yang, H. (eds), Advances in Statistics, Probability and Actuarial Science: Stochastic Processes, Finance and Control, World Scientific, USA, pp. 217-234.
Chiarella, C., Flaschel, P. & Semmler, W. 2012, 'A macrodynamic model of real-financial interaction: Implications of budget equations and capital accumulation' in Kyrtsou, C. & Vorlow, C. (eds), Progress in Financial Markets Research, Nova Science Publishers Inc, New York, USA, pp. 243-262.
In this paper, we investigate the real-financial interaction of an approach of Blanchard to stock market and multiplier dynamics from the stock-flow consistency perspective by including the capacity and the financing effect of the investment decision of firms into the model. We thus add budget equations as well as the growth law for the capital stock to the Blanchard dynamics and investigate the implications of these additions for steady state locations and their stability. We show that the steady state solutions of the Blanchard approach are no longer of relevance here, but rather are replaced by a unique interior long-run solution. We demonstrate asymptotic stability with respect to this steady state when stock market adjustment is sufficiently sluggish, and this even in the case of myopic perfect foresight. In the opposite situation, if stock market adjustment is made sufficiently fast, the system loses stability by way of a Hopf bifurcation for increasing adjustment speeds of capital gains expectations and will generate purely explosive behavior shortly thereafter.
Chiarella, C., Ziogas, A. & Ziveyi, J. 2010, 'Representation of American Option Prices Under Heston Stochastic Volatility Dynamics Using Integral Transforms', pp. 281-315.
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Chiarella, C., Dieci, R. & He, X. 2009, 'Heterogeneity, market mechanisms and asset price dynamics' in Hens, T. & Schenk-Hoppe, K.R. (eds), Handbook of Financial Markets: Dynamics and Evolution, Elsevier, USA, pp. 277-344.
Chiarella, C., Meyer, G. & Ziogas, A. 2008, 'Pricing American Options Under Stochastic Volatility and Jump-Diffusion Dynamics' in Muller, K. & Steffens, U. (eds), Die Zukunft der Finanzdienstleistungs-industrie in Deutschland, Frankfurt School Verlag, Frankfurt, Germany, pp. 213-236.
Chiarella, C., El-Hassan, N. & Kucera, A. 2008, 'The evaluation of discrete barrier options in a path integral framework' in Kontoghiorghes, E., Rustem, B. & Winker, P. (eds), Computational Methods in Financial Engineering: Essays in Honour of Manfred Gilli, Springer, Germany, pp. 117-144.
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The pricing of discretely monitored barrier options is a difficult problem. In general, there is no known closed form solution for pricing such options. A path integral approach to the evaluation of barrier options is developed. This leads to a backward recursion functional equation linking the pricing functions at successive barrier points. This functional equation is solved by expanding the pricing functions in Fourier-Hermite series. The backward recursion functional equation then becomes the backward recurrence relation for the coefficients in the Fourier-Hermite expansion of the pricing functions. A very efficient and accurate method for generating the pricing function at any barrier point is thus obtained. A number of numerical experiments with the method are performed in order to gain some understanding of the nature of convergence. Results for various volatility values and different numbers of basis functions in the Fourier-Hermite expansion are presented. Comparisons are given between pricing of discrete barrier option in the path integral framework and by use of finite difference methods.
Chiarella, C. & He, X. 2008, 'An adaptive model of asset price and wealth dynamics in a market with heterogeneous trading strategies' in Seese, D., Weinhardt, C. & Schlottmann, F. (eds), Handbook on Information Technology in Finance, Springer, Germany, pp. 465-499.
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The traditional asset-pricing models such as the capital asset pricing model (CAPM) of [42] and [34], the arbitrage pricing theory (APT) of [40], or the intertemporal capital asset pricing model (ICAPM) of [38] have as one of their important assumptions, investor homogeneity. In particular the paradigm of the representative agent assumes that all agents are homogeneous with regard to their preferences, their expectations and their investment strategies.1 However, as already argued by Keynes in the 1930s, agents do not have sufficient knowledge of the structure of the economy to form correct mathematical expectations that would be held by all agents
Asada, T., Chiarella, C., Flaschel, P. & Franke, R. 2007, 'Interacting Two-Country Business Fluctuations: Euroland and the USA' in Mazzi, G. & Savio, G. (eds), Growth and Cycle in the Eurozone, Palgrave Macmillan, New York, USA, pp. 109-118.
This book presents recent theoretical and empirical advances on business cycles analysis with particular attention to Euro-zone characteristics. It also identifies applications of sophisticated tools by private and public institutions involved in the analysis of economic fluctuations and seeks to increase interaction between the academics, researchers and institutions in the area of business cycle analysis. This volume encompasses methodological advances in several important areas for business cycle analysis, such as multivariate statistical methods, synchronization and convergence, composite indicators, turning points dating and detection, output gap measurement, as well as innovative applications of the existing theories and methods to the economy of the Euro-zone.
Asada, T., Chen, P., Chiarella, C. & Flaschel, P. 2006, 'AD-AS and the Phillips curve: a baseline disequilibrium model' in Chiarella, C., Franke, R., Flaschel, P. & Semmler, W. (eds), Quantitative and Empirical Analysis of Nonlinear Dynamic Macromodels, Elsevier, Amsterdam, Netherlands, pp. 173-227.
Chen, P., Chiarella, C., Flaschel, P. & Semmler, W. 2006, 'Keynesian macrodynamics and the Phillip curve: an estimated model for the US economy' in Chiarella, C., Franke, R., Flaschel, P. & Semmler, W. (eds), Quantitative and Empirical Analysis of Nonlinear Dynamic Macromodels, Elsevier, Amsterdam, Netherlands, pp. 229-284.
Chiarella, C., Flaschel, P., Franke, R. & Semmler, W. 2006, 'A high-dimensional model of real-financial market interaction: the cascade of stable matrices approach' in Chiarella, C., Franke, R., Flaschel, P. & Semmler, W. (eds), Quantitative and Empirical Analysis of Nonlinear Dynamic Macromodels, Elsevier, Amsterdam, Netherlands, pp. 359-384.
Chiarella, C., He, X. & Wang, D. 2006, 'Statistical properties of a heterogeneous asset pricing model with time-varying second moment' in Namatame, A., Kaizouji, T. & Aruka, Y. (eds), The Complex Networks of Economic Interactions: essays in agent-based economics & econophysics, Springer, Berlin, Germany, pp. 109-123.
Chiarella, C., Flaschel, P., He, X. & Hung, H. 2006, 'A stochastic model of real-financial interaction with boundedly rational heterogeneous agents' in Chiarella, C., Franke, R., Flaschel, P. & Semmler, W. (eds), Quantitative and Empirical Analysis of Nonlinear Dynamic Macromodels, Elsevier, Amsterdam, Netherlands, pp. 333-358.
Chiarella, C., Dieci, R. & Gardini, L. 2005, 'Asset price dynamics and diversification with heterogeneous agents' in Lux, T., Reitz, S. & Samanidou, E. (eds), Nonlinear Dynamics and Heterogeneous Interacting Agents, Springer, Berlin, Germany, pp. 251-267.
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A discrete-time dynamic model of a financial market is developed, where two types of agents, fundamentalists and chartists, allocate their wealth between two risky assets and a safe asset, according to one-period mean-variance maximization. The two groups of agents form different expectations about asset returns and their variance/covariance structure, and this results in different demand functions. At the end of each trading period, agents' demands are aggregated by a market maker, who sets the next period prices as functions of the excess demand. The model results in a high-dimensional nonlinear discrete-time dynamical system, which describes the time evolution of prices and agents' beliefs about expected returns, variances and correlation. It is shown that the unique steady state may become unstable through a Hopf-bifurcation and that an attracting limit cycle, or more complex attractors, exist for particular ranges of the key parameters. In particular, the two risky assets may exhibit coupled long-run price fluctuations and time-varying correlation of returns.
Chiarella, C. & He, X. 2005, 'An asset pricing model with adaptive heterogeneous agents and wealth effects' in Lux, T., Reitz, S. & Samanidou, E. (eds), Nonlinear Dynamics and Heterogeneous Interacting Agents, Springer, Berlin, Germany, pp. 269-285.
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The characterisation of agents' preferences by decreasing absolute risk aversion (DARA) and constant relative risk aversion (CRRA) are well documented in the literature and also supported in both empirical and experimental studies. This paper considers a financial market with heterogeneous agents having power utility functions, which are the only utility functions displaying both DARA and CRRA. By introducing a population weighted average wealth measure, we develop an adaptive model to characterise asset price dynamics as well as the evolution of population proportions and wealth dynamics. Some numerical simulations are included to illustrate the evolution of the wealth dynamics, market behaviour and market efficiency within the framework of heterogeneous agents.
Chiarella, C., Flaschel, P. & Semmler, W. 2004, 'Real-financial interaction: A reconsideration of the Blanchard model with a state-of-market dependent reaction coefficient', pp. 31-65.
Chiarella, C. & He, X.Z. 2004, 'Dynamics of beliefs and learning under a(L)-processes - The homogeneous case', pp. 363-390.
Chiarella, C., Dieci, R. & Gardini, L. 2004, 'A dynamical analysis of speculation across two markets.' in Gallegati, M., Kirman, A.P. & Marsili, M. (eds), The Complex Dynamics of Economic Interaction: essays in economics and econophysics, Springer, Heidelberg, pp. 197-212.
Chiarella, C., Szidarovszky, F. & Zhu, P.Y. 2002, 'The interaction of uncertainty and information lags in the Cournot oligopoly model', pp. 233-263.
Chiarella, C. & Khomin, A. 2002, 'Learning in a generalised Dornbusch model of exchange rate dynamics' in Woodland, A.D. (ed), Economic Theory and International Trade: essays in honour of Murray C Kemp, Edward Elgar Publishing Ltd, Cheltenham, pp. 249-267.
Bhar, R., Chiarella, C. & Runggaldier, W.J. 2002, 'Estimation in models of the instantaneous short term interest rate by use of a dynamic Bayesian algorithm' in Sandmann, K. & Schonbucher, P.J. (eds), Advances in Finance and Stochastics: essays in honour of Dieter Sondermann, Springer-Verlag, Berlin, Germany, pp. 177-195.
Chiarella, C. & Szidarovszky, F. 2002, 'The birth of limit cycles in nonlinear oligopolies with continuously distributed information lag' in Dror, M., L'Ecuyer, P. & Szidarovszky, F. (eds), Modeling Uncertainty - An examination of stochastic theory, methods, and applications, Kluwer Academic Publishers, Boston, pp. 249-268.
Chiarella, C., Pasquali, S. & Runggaldier, W.J. 2002, 'On Filtering in Markovian Term Structure Models' in Yong, J. (ed), Recent Developments in Mathematical Finance, World Scientific, Singapore, pp. 139-150.
Chiarella, C., Flaschel, P., Franke, R. & Semmler, W. 2001, 'Output, Financial Markets & Growth. An Extension of the Balnchard Stock-Market Approach' in Friedman, R., Knuppel, L. & Lutkepohl, H. (eds), Econometric Studies: A Festschrift in Honour of Joachim Frohn, LIT Verlag, Munster, Germany, pp. 159-183.
Chiarella, C., Flaschel, P. & Semmler, W. 2001, 'The macrodynamics of debt deflation', pp. 133-184.
Chiarella, C. & Khomin, A. 2000, 'The dynamic interaction of rational fundamentalists and trend chasing chartists in a monetary economy', pp. 151-165.
Chiarella, C., Flaschel, P., Groh, G. & Semmler, W. 2000, 'AS-AD disequilibrium dynamics and economic growth' in Hartl, E.J., Dockner, R.F., Luptacik, M. & Sorger, G. (eds), Optimization, Dynamics, and Economic Analysis, Physica-Verlag, Heidelberg, Germany, pp. 101-117.
Chiarella, C. & Flaschel, P. 2000, 'The emergence of complex dynamics in a "naturally" nonlinear integrated Keynesian model of monetary growth', pp. 111-145.
Bhar, R. & Chiarella, C. 2000, 'Analysis of time varying exchange rate risk premia', pp. 255-273.
Chiarella, C. & He, X. 2000, 'The dynamics of the cobweb when producers are risk averse learners' in Hartl, E.J., Dockner, R.F., Luptacik, M. & Sorger, G. (eds), Optimization, Dynamics, and Economic Analysis, Physica-Verlag, Heidelberg, Germany, pp. 86-100.
Journal articles
Chiarella, C. & Ziveyi, J. 2014, 'Pricing American options written on two underlying assets', QUANTITATIVE FINANCE, vol. 14, no. 3, pp. 409-426.
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Chiarella, C. & Di Guilmi, C. 2014, 'Financial instability and debt deflation dynamics in a bottom-up approach', Economics Bulletin, vol. 34, no. 1, pp. 125-132.
Chiarella, C., Griebsch, S. & Kang, S. 2014, 'A comparative study on time-efficient methods to price compound options in the Heston model', COMPUTERS & MATHEMATICS WITH APPLICATIONS, vol. 67, no. 6, pp. 1254-1270.
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Chiarella, C., He, X.-.Z. & Zwinkels, R.C.J. 2014, 'Heterogeneous expectations in asset pricing: Empirical evidence from the S & P500', JOURNAL OF ECONOMIC BEHAVIOR & ORGANIZATION, vol. 105, pp. 1-16.
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Lian, G., Chiarella, C. & Kalev, P. 2014, 'Volatility swaps and volatility options on discretely sampled realized variance', Journal of Economic Dynamics and Control.
Chiarella, C. & Di Guilmi, C. 2014, 'The limit distribution of evolving strategies in financial markets', Studies in Nonlinear Dynamics and Econometrics.
Cheang, G.H., Chiarella, C. & Ziogas, A. 2013, 'The representation of American options prices under stochastic volatility and jump-diffusion dynamics', Quantitative Finance, vol. 13, no. 2, pp. 241-253.
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This paper considers the problem of pricing American options when the dynamics of the underlying are driven by both stochastic volatility following a square-root process as used by Heston [Rev. Financial Stud., 1993, 6, 327343], and by a Poisson jump process as introduced by Merton [J. Financial Econ., 1976, 3, 125144]. Probability arguments are invoked to find a representation of the solution in terms of expectations over the joint distribution of the underlying process. A combination of Fourier transform in the log stock price and Laplace transform in the volatility is then applied to find the transition probability density function of the underlying process. It turns out that the price is given by an integral dependent upon the early exercise surface, for which a corresponding integral equation is obtained. The solution generalizes in an intuitive way the structure of the solution to the corresponding European option pricing problem obtained by Scott [Math. Finance, 1997, 7(4), 413426], but here in the case of a call option and constant interest rates
Matsumoto, A., Chiarella, C. & Szidarovszky, F. 2013, 'Dynamic monopoly with bounded continuously distributed delay', CHAOS SOLITONS & FRACTALS, vol. 47, pp. 66-72.
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This paper proposes a model for pricing credit derivatives in a defaultable HJM framework. The model features hump-shaped, level dependent, and unspanned stochastic volatility, and accommodates a correlation structure between the stochastic volatility, the default-free interest rates, and the credit spreads. The model is finite-dimensional, and leads (a) to exponentially affine default-free and defaultable bond prices, and (b) to an approximation for pricing credit default swaps and swaptions in terms of defaultable bond prices with varying maturities. A numerical study demonstrates that the model captures stylized various features of credit default swaps and swaptions Read More: http://www.worldscientific.com.ezproxy.lib.uts.edu.au/doi/abs/10.1142/S0219024913500192
Chiarella, C., He, X. & Zheng, M. 2013, 'Heterogeneous expectations and exchange rate dynamics', The European Journal of Finance, vol. 19, no. 5, pp. 392-419.
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This article presents a continuous-time model of exchange rates not only relying on macroeconomic factors but also having an investor heterogeneity component. The driving macroeconomic factor is the domesticforeign interest rate differential, while the investor heterogeneity is described by the expectations of boundedly rational portfolio managers who use a weighted average of the expectations of fundamentalists and chartists. Within this framework, the different roles of the macroeconomic factor and investor heterogeneity in the determination of the exchange rate are examined explicitly. We show that this simple model generates very complicated market behaviour, including the existence of multiple steady-state equilibria, deviations of the market exchange rate from the fundamental one and market fluctuations. Numerical simulation of the corresponding stochastic version of the model shows that the model is able to generate typical time series and volatility clustering patterns observed in exchange rate markets.
Chiarella, C., Dieci, R. & He, X. 2013, 'Time-varying beta: A boundedly rational equlibrium approach', Journal of Evolutionary Economics, vol. 23, no. 3, pp. 609-639.
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The conditional CAPM with time-varying betas has been widely used to explain the cross-section of asset returns. However, most of the literature on time-varying beta is motivated by econometric estimation using various latent risk factors rather than explicit modelling of the stochastic behaviour of betas through agents behaviour, such as momentum trading. Misspecification of beta risk and the lack of any theoretical guidance on how to specify risk factors based on the representative agent economy appear empirically challenging. In this paper, we set up a dynamic equilibrium model of a financial market with boundedly rational and heterogeneous agents within the mean-variance framework of repeated one-period optimisation and develop an explicit dynamic behaviour CAPM relation between the expected equilibrium returns and time-varying betas. By incorporating the two most commonly used types of investors, fundamentalists and chartists, into the model, we show that there is a systematic change in the market portfolio, risk-return relationships, and time varying betas when investors change their behaviour, such as the chartists acting as momentum traders. In particular, we demonstrate the stochastic nature of time-varying betas. We also show that the commonly used rolling window estimates of time-varying betas may not be consistent with the ex-ante betas implied by the equilibrium model. The results provide a number of insights into an understanding of time-varying beta.
Chiarella, C., Dieci, R., He, X. & Li, K. 2013, 'An evolutionary CAPM under heterogeneous beliefs', Annals of Finance, vol. 9, no. 2, pp. 185-215.
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Heterogeneity and evolutionary behaviour of investors are two of the most important characteristics of financial markets. This paper incorporates the adaptive behaviour of agents with heterogeneous beliefs and establishes an evolutionary capital asset pricing model (ECAPM) within the mean-variance framework. We show that the rational behaviour of agents switching to better-performing trading strategies can cause large deviations of the market price from the fundamental value of one asset to spill over to other assets. Also, this spill-over effect is associated with high trading volumes and persistent volatility characterized by significantly decaying autocorrelations of, and positive correlation between, price volatility and trading volume.
Chiarella, C., Matsumoto, A. & Szidarovszky, F. 2013, 'Isoelastic oligopolies under uncertainty', APPLIED MATHEMATICS AND COMPUTATION, vol. 219, no. 21, pp. 10475-10486.
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Chiarella, C., Kang, B., Nikitopoulos Sklibosios, C. & To, T.D. 2013, 'Humps in the volatility structure of the crude oil futures market: New evidence', Energy Economics, vol. 40, no. 1, pp. 989-1000.
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This paper analyses the volatility structure of commodity derivatives markets. The model encompasses hump-shaped, unspanned stochastic volatility, which entails a finite-dimensional affine model for the commodity futures curve and quasi-analytical prices for options on commodity futures. Using an extensive database of crude oil futures and futures options spanning 21 years, we find the presence of hump-shaped, partially spanned stochastic volatility in the crude oil market. The hump shaped feature is more pronounced when the market is more volatile, and delivers better pricing as well as hedging performance under various dynamic factor hedging schemes.
Chiarella, C. & Ziveyi, J. 2013, 'American option pricing under two stochastic volatility processes', Applied mathemetics and computation, vol. 224, no. 1, pp. 283-310.
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In this paper we consider the pricing of an American call option whose underlying asset dynamics evolve under the influence of two independent stochastic volatility processes as proposed in Christoffersen, Heston and Jacobs (2009) [13]. We consider the associated partial differential equation (PDE) for the option price and its solution. An integral expression for the general solution of the PDE is presented by using Duhamels principle and this is expressed in terms of the joint transition density function for the driving stochastic processes. For the particular form of the underlying dynamics we are able to solve the Kolmogorov PDE for the joint transition density function by first transforming it to a corresponding system of characteristic PDEs using a combination of Fourier and Laplace transforms. The characteristic PDE system is solved by using the method of characteristics. With the full price representation in place, numerical results are presented by first approximating the early exercise surface with a bivariate log linear function. We perform numerical comparisons with results generated by the method of lines algorithm and note that our approach provides quite good accuracy
Chiarella, C. & Kang, B. 2013, 'The evaluation of American compound option prices under stochastic volatility and stochastic interest rates', Journal of Computational Finance, vol. 17, no. 1, pp. 71-92.
A compound option (the mother option) gives the holder the right, but not the obligation, to buy (long) or sell (short) the underlying option (the daughter option). In this paper, we consider the problem of pricing American-type compound options when the underlying dynamics follow Heston 's stochastic volatility and with stochastic interest rate driven by Cox-Ingersoll-Ross processes. We use a partial differential equation (PDE) approach to obtain a numerical solution. The problem is formulated as the solution to a two-pass free-boundary PDE problem, which is solved via a sparse grid approach and is found to be accurate and efficient compared with the results from a benchmark solution based on a least-squares Monte Carlo simulation combined with the projected successive over-relaxation method.
Chiarella, C. 2013, 'Le prospettive per la teoria economica nei prossimi 30 anni', Pristem Storis: note di matematica, storia e cultura, vol. 31, no. Feb, pp. 79-88.
Questo articolo riassume gli sviluppi nella teoria economica durante gli ultimi settanta anni. Si evidenzia come la teoria abbia oscillato fra due punti di vista, quello keynesiano negli anni '30, per poi successivamente essere dominata dal punto di vista neoclassico. Recentemente Ie idee keynesiane sono state oggetto di un rinnovato interesse. I;articolo esamina anche i principali metodi matematici dei due campi.
Chiarella, C., He, X.-.Z., Huang, W. & Zheng, H. 2012, 'Estimating behavioural heterogeneity under regime switching', JOURNAL OF ECONOMIC BEHAVIOR & ORGANIZATION, vol. 83, no. 3, pp. 446-460.
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Chiarella, C., He, X. & Pellizzari, P. 2012, 'A dynamic analysis of the microstructure of moving average rules in a double auction market', Macroeconomic Dynamics, vol. 16, no. 4, pp. 556-575.
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Inspired by the theoretically oriented dynamic analysis of moving average rules in the model of Chiarella, He, and Hommes (CHH) [Journal of Economic Dynamics and Control 30 (2006), 1729-1753], this paper conducts a dynamic analysis of a more realistic microstructure model of continuous double auctions in which the probability of heterogeneous agents trading is determined by the rules of either fundamentalists mean-reverting to the fundamental or chartists choosing moving average rules based on their relative performance. With such a realistic market microstructure, the model is able not only to obtain the results of the CHH model but also to characterize most of the stylized facts including volatility clustering, insignificant autocorrelations (ACs) of returns, and significant slowly decaying ACs of the absolute returns. The results seem to suggest that a comprehensive explanation of several statistical properties of returns is possible in a framework where both behavioral traits and realistic microstructure have a role
Chiarella, C., Flaschel, P., Koeper, C., Proano, C. & Semmler, W. 2012, 'Macroeconomic Stabilization Policies in Intrinsically Unstable Macroeconomies', STUDIES IN NONLINEAR DYNAMICS AND ECONOMETRICS, vol. 16, no. 2.
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Chiarella, C., Kang, B. & Meyer, G. 2012, 'The evaluation of barrier option prices under stochastic volatility', Computers & Mathematics With Applications, vol. 64, no. 6, pp. 2034-2048.
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This paper considers the problem of numerically evaluating barrier option prices when the dynamics of the underlying are driven by stochastic volatility following the square root process of Heston (1993)[7]. We develop a method of lines approach to evaluate the price as well as the delta and gamma of the option. The method is able to efficiently handle both continuously monitored and discretely monitored barrier options and can also handle barrier options with early exercise features. In the latter case, we can calculate the early exercise boundary of an American barrier option in both the continuously and discretely monitored cases.
Giansante, S., Chiarella, C., Sordi, S. & Vercelli, A. 2012, 'Structural contagion and vulnerability to unexpected liquidity shortfalls', JOURNAL OF ECONOMIC BEHAVIOR & ORGANIZATION, vol. 83, no. 3, pp. 558-569.
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Chiarella, C., Flaschel, P., Hartmann, F. & Proano, C.R. 2012, 'Stock market booms, endogenous credit creation and the implications of broad and narrow banking for macroeconomic stability', JOURNAL OF ECONOMIC BEHAVIOR & ORGANIZATION, vol. 83, no. 3, pp. 410-423.
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Roethig, A. & Chiarella, C. 2011, 'SMALL TRADERS IN CURRENCY FUTURES MARKETS', JOURNAL OF FUTURES MARKETS, vol. 31, no. 9, pp. 898-913.
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Chiarella, C., Fanelli, V. & Musti, S. 2011, 'Modelling the evolution of credit spreads using the Cox process within the HJM framework: A CDS option pricing model', European Journal Of Operational Research, vol. 208, no. 2, pp. 95-108.
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In this paper a simulation approach for defaultable yield curves is developed within the Heath et al. (1992) framework. The default event is modelled using the Cox process where the stochastic intensity represents the credit spread. The forward credit spread volatility function is affected by the entire credit spread term structure. The paper provides the defaultable bond and credit default swap option price in a probability setting equipped with a subfiltration structure. The EulerMaruyama stochastic integral approximation and the Monte Carlo method are applied to develop a numerical scheme for pricing. Finally, the antithetic variable technique is used to reduce the variance of credit default swap option prices.
Chiarella, C. & Di Guilmi, C. 2011, 'The financial instability hypothesis: A stochastic microfoundation framework', Journal of Economic Dynamics and Control, vol. 35, no. 8, pp. 1151-1171.
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This paperexaminesthedynamicsoffinancialdistressandinparticularthemechanism of transmissionofshocksfromthefinancialsectortotherealeconomy.Theanalysisis performedbyrepresentingthelinkagesbetweenmicroeconomicfinancialvariablesand the aggregateperformanceoftheeconomybymeansofamicrofoundedmodelwith firms thathaveheterogeneouscapitalstructures.Themodelissolvedbothnumerically and analytically,bymeansofastochasticapproximationthatisabletoreplicatequite well thenumericalsolution.Thesemethodologies,byovercomingtherestrictions imposedbythetraditionalmicrofoundedapproach,enableustoprovidesomeinsights into thestabilizationpolicieswhichmaybeeffectiveinafinanciallyfragilesystem.
Chiarella, C., Dieci, R. & He, X.-.Z. 2011, 'Do heterogeneous beliefs diversify market risk?', EUROPEAN JOURNAL OF FINANCE, vol. 17, no. 3, pp. 241-258.
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Chiarella, C., He, X.-.Z. & Zheng, M. 2011, 'An analysis of the effect of noise in a heterogeneous agent financial market model', JOURNAL OF ECONOMIC DYNAMICS & CONTROL, vol. 35, no. 1, pp. 148-162.
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Asada, T., Chiarella, C., Flaschel, P., Mouakil, T., Proano, C. & Semmler, W. 2011, 'STOCK-FLOW INTERACTIONS, DISEQUILIBRIUM MACROECONOMICS AND THE ROLE OF ECONOMIC POLICY', JOURNAL OF ECONOMIC SURVEYS, vol. 25, no. 3, pp. 569-599.
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Bischi, G., Chiarella, C. & Gardini, L. 2011, 'Foreward to the special issue of computational economics on complex dynamics in economics and finance', Computational Economics, vol. 38, no. 3, pp. 207-208.
Chiarella, C., Dieci, R. & He, X. 2011, 'The dynamic behaviour of asset prices in disequilibrium: a survey', International Journal of Behavioural Accounting and Finance, vol. 2, no. 2, pp. 101-139.
This article surveys boundedly rational heterogeneous agent (BRHA) models of financial markets. We give particular emphasis to the role of the market clearing mechanism used, the utility function of the investors, the interaction of price and wealth dynamics, and calibration of this class of models. Due to agents behavioural features and market noise, the BRHA class of models are both non-linear and stochastic. We show that BRHA models produce both a locally stable fundamental equilibrium corresponding to that of the standard paradigm, as well as instability with a consequent rich range of possible complex behaviours that are analysed by both simulation and deterministic bifurcation analysis. A calibrated model is able to reproduce quite well the stylised facts of financial markets. The BRHA framework seems able to better accommodate market features such as fat tails, volatility clustering, large excursions from the fundamental and bubbles than the standard financial market paradigm.
Cheang, G.H. & Chiarella, C. 2011, 'Exchange Options Under Jump-Diffusion Dynamics', Applied Mathematical Finance, vol. 18, no. 3, pp. 245-276.
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This article extends the exchange option model of Margrabe, where the distributions of both stock prices are log-normal with correlated Wiener components, to allow the underlying assets to be driven by jump-diffusion processes of the type originally introduced by Merton. We introduce the RadonNikodym derivative process that induces the change of measure from the market measure to an equivalent martingale measure. The choice of parameters in the RadonNikodym derivative allows us to price the option under different financial-economic scenarios. We also consider American style exchange options and provide a probabilistic interpretation of the early exercise premium.
Asada, T., Chiarella, C., Flaschel, P., Mouakil, T., Proano, C.R. & Semmler, W. 2010, 'Stabilizing an Unstable Economy: On the Choice of Proper Policy Measures', ECONOMICS-THE OPEN ACCESS OPEN-ASSESSMENT E-JOURNAL, vol. 4.
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Chiarella, C. & Flaschel, P. 2010, 'Some numerical explorations of the Keynes-Metzler-Goodwin monetary growth model', Indian Economic Review, vol. 45, no. 1, pp. 1-28.
We study numerically Keynes-Metzler-Goodwin growth, modelling households, firms and government as interacting across real and financial markets. The model allows for sluggish wage / price adjustment, disequilibrium on the market for goods, equilibrium in asset markets and a dynamic government budget restraint. It is first studied in the presence of its intrinsic nonlinearities. Then we add an extrinsic nonlinearity capturing the institutional feature of downward wage rigidity. The dynamic properties of the resulting nonlinear model are studied via bifurcation diagrams, stability basins, by adding stochastic noise to aggregate demand, and by distributional characteristics of key economic quantities.
Chiarella, C., Hung, H. & Flaschel, P. 2010, 'Keynesian Macrodynamics: Convergence, roads to instability and the emergence of complex business fluctuations', AUCO Czech Economic Review, vol. 4, no. 3, pp. 236-262.
We reformulate the traditional AS-AD growth model, with a Taylor policy rule replacing the conventional LM-curve. The essential features of the model are gradually adjusting wages and prices, perfect foresight on current inflation rates and an adaptive revision of the inflationary climate in which the economy is operating. We compare this approach with the New Keynesian approach with staggered price and wage setting and find that whilst both approaches have common components, they have radically different dynamic implications due to the treatment of the forward-looking part of our wage-price spiral. We show that an estimated version of our model implies local asymptotic stability, due to stable interaction of goods market dynamics with the interest rate policy rule of the central bank, and due to a normal working of a real-wage feedback chain. These results are however endangered when there is a global floor to money wage inflation rates, leading in fact to economic breakdown. In this latter case, the return of some money wage flexibility in deep depressions is of help in restoring the viability of the model, thereby avoiding explosive dynamics and the collapse of the economy.
Chiarella, C. & Szidarovsky, F. 2009, 'Dynamic oligopolies and intertemporal demand interaction', CUBO Matematica Educational, vol. 11, no. 2, pp. 85-105.
Dynamic oligopolies are examined with continuous time scales and under the assumption that the demand at each time period is affected by earlier demands and consumptions. After the mathematical model is introduced the local asymptotical stability of the equilibrium is examined, and then we will discuss how information delays alter the stability conditions. We will also investigate the occurrence of a Hopf bifurcation gving the possibility of the birth of limit cycles. Numerical examples will be shown toillustrate the theoretical results.
Chiarella, C. & Szidarovsky, F. 2009, 'A multiobjective model of oligopolies under uncertainty', CUBO Matematica Educational, vol. 11, no. 2, pp. 107-115.
It is assumed that in an n-firm single-product oligopoly without product differentiation the firms face an uncertain price function, which is considered random by the firms. At each time period each firm simultaneously maximizes its expected profit and minimizes the variance of the profit since it wants to receive as high as possible profit with the least possible uncertainty. It is assumed that the best response of each firm is obtained by the weighting method. We show the existence of a unique equilibrium, and investigate the local stability of the equilibrium.
Bhar, R. & Chiarella, C. 2009, 'Inference on forward exchange rate risk premium: Reviewing signal extraction methods', International Journal of Monetary Economics and Finance, vol. 2, no. 2, pp. 115-125.
The existence of risk premium is thought to be the reason why forward exchange rate is not an unbiased predictor of future spot exchange rate. In this paper we review two methodologies for inferring this unobserved risk premium based upon signal extraction mechanism. One approach relies on the theory of derivatives pricing that relates historical and risk neutral measures via market price of risk. The other approach specifies the risk premium in the historical measure directly. We compare these two methods in predicting future spot exchange rates and contrast these with that of random walk forecast
Chiarella, C. & Szidarovsky, F. 2009, 'Existence and uniqueness in Cournot models with cost externalities', Mathematica Pannonica, vol. 20, no. 1, pp. 17-25.
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In this paper we examine single product Cournot oligopolies, with- out product differentiation, under the assumption that the cost of each firm depends on its own output and also on the output of the rest of the industry. The competition of the firms on the secondary market for manpower, capital, energy, and so forth as well as the spillover effect of the R&D investments of the firms can be taken into account with this more general cost structure. The existence of a unique NashCournot equilibrium is proved under realistic conditions. Our result is a straightforward generalization of the well-known existence and uniqueness theorem of concave oligopolies.
Chiarella, C., Kang, B., Meyer, G. & Ziogas, A. 2009, 'The evaluation of American option prices under stochastic volatility and jump diffusion dynamics using the method of lines', International Journal of Theoretical and Applied Finance, vol. 12, no. 3, pp. 393-425.
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This paper considers the problem of numerically evaluating American option prices when the dynamics of the underlying are driven by both stochastic volatility following the square root process of Heston [18], and by a Poisson jump process of the type originally introduced by Merton [25]. We develop a method of lines algorithm to evaluate the price as well as the delta and gamma of the option, thereby extending the method developed by Meyer [26] for the case of jump-diffusion dynamics. The accuracy of the method is tested against two numerical methods that directly solve the integro-partial differential pricing equation. The first is an extension to the jump-diffusion situation of the componentwise splitting method of Ikonen and Toivanen [21]. The second method is a Crank-Nicolson scheme that is solved using projected successive over relaxation and which is taken as the benchmark for the price. The relative efficiency of these methods for computing the American call option price, delta, gamma and free boundary is analysed. If one seeks an algorithm that gives not only the price but also the delta and gamma to the same level of accuracy for a given computational effort then the method of lines seems to perform best amongst the methods considered.
Zhu, M., Chiarella, C., He, X.-.Z. & Wang, D. 2009, 'Does the market maker stabilize the market?', PHYSICA A-STATISTICAL MECHANICS AND ITS APPLICATIONS, vol. 388, no. 15-16, pp. 3164-3180.
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Chiarella, C., Iori, G. & Perello, J. 2009, 'The impact of heterogeneous trading rules on the limit order book and order flows', Journal of Economic Dynamics and Control, vol. 33, no. 3, pp. 525-537.
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In this paper we develop a model of an order-driven market where traders set bids and asks and post market or limit orders according to exogenously fixed rules. Agents are assumed to have three components of the expectation of future asset returns, namely fundamentalist, chartist and noise trader. Furthermore agents differ in the characteristics describing these components, such as time horizon, risk aversion and the weights given to the various components. The model developed here extends a great deal of earlier literature in that the order submissions of agents are determined by utility maximisation, rather than the mechanical unit order size that is commonly assumed. In this way the order flow is better related to the ongoing evolution of the market. For the given market structure we analyze the impact of the three components of the trading strategies on the statistical properties of prices and order flows and observe that it is the chartist strategy that is mainly responsible of the fat tails and clustering in the artificial price data generated by the model. The paper provides further evidence that large price changes are likely to be generated by the presence of large gaps in the book.
Chiarella, C., Hung, H. & To, T. 2009, 'The volatility structure of the fixed income market under the HJM framework: A nonlinear filtering approach', Computational Statistics and Data Analysis, vol. 53, no. 6, pp. 2075-2088.
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The dynamics for interest rate processes within the well-known multi-factor Heath, Jarrow and Morton (HJM) specification are considered. Despite the flexibility of and the notable advances in theoretical research about the HJM model, the number of empirical studies of it is still very sparse. This paucity is principally due to the difficulties in estimating models in this class, which are not only high-dimensional, but also nonlinear and involve latent state variables. The estimation of a fairly broad class of HJM models as a nonlinear filtering problem is undertaken by adopting the local linearization filter, which is known to have some desirable statistical and numerical features, so enabling the estimation of the model via the maximum likelihood method. The estimator is then applied to the US, the UK and the Australian markets. Different two- and three-factor models are found to be the best for each market, with the factors being the level, the slope and the twist effect. The contribution of each factor towards overall variability of the interest rates and the financial reward each factor claims are found to differ considerably from one market to another.
Chiarella, C. & Ziogas, A. 2009, 'American Call Options Under Jump-Diffusion Processes - A Fourier Transform Approach', Applied Mathematical Finance, vol. 16, no. 1, pp. 37-79.
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We consider the American option pricing problem in the case where the underlying asset follows a jump-diffusion process. We apply the method of Jamshidian to transform the problem of solving a homogeneous integro-partial differential equation (IPDE) on a region restricted by the early exercise (free) boundary to that of solving an inhomogeneous IPDE on an unrestricted region. We apply the Fourier transform technique to this inhomogeneous IPDE in the case of a call option on a dividend paying underlying to obtain the solution in the form of a pair of linked integral equations for the free boundary and the option price. We also derive new results concerning the limit for the free boundary at expiry. Finally, we present a numerical algorithm for the solution of the linked integral equation system for the American call price, its delta and the early exercise boundary. We use the numerical results to quantify the impact of jumps on American call prices and the early exercise boundary.
Chiarella, C., Dieci, R., Gardini, L. & Sbragia, L. 2008, 'A model of financial market dynamics with heterogeneous beliefs and state-dependent confidence', COMPUTATIONAL ECONOMICS, vol. 32, no. 1-2, pp. 55-72.
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Chiarella, C., He, X.-.Z., Wang, D. & Zheng, M. 2008, 'The stochastic bifurcation behaviour of speculative financial markets', PHYSICA A-STATISTICAL MECHANICS AND ITS APPLICATIONS, vol. 387, no. 15, pp. 3837-3846.
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Chiarella, C. & Szidarovszky, F. 2008, 'Dynamic Oligopolies with Production Adjustment Costs', SCIENTIA IRANICA, vol. 15, no. 1, pp. 120-124.
Roethig, A. & Chiarella, C. 2007, 'Investigating nonlinear speculation in cattle, corn, and hog futures markets using logistic smooth transition regression models', JOURNAL OF FUTURES MARKETS, vol. 27, no. 8, pp. 719-737.
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Chiarella, C., Hsiao, C. & Semmler, W. 2007, 'Intertemporal Asset Allocation when the Underlying Factors are Unobservable', Computational Economics, vol. 29, no. 3-4, pp. 383-418.
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The aim of this paper is to develop an optimal long-term bond investment strategy which can be applied to real market situations. This paper employs Merton?s intertemporal framework to accommodate the features of a stochastic interest rate and the time-varying dynamics of bond returns.The long-term investors encounter a partial information problem where they can only observe the market bond prices but not the driving factors of the variability of the interest rate and the bond return dynamics.With the assumption of Gaussian factor dynamics, we are able to develop an analytical solution for the optimal long-term investment strategies under the case of full information. To apply the best theoretical investment strategy to the real market we need to be aware of the existence of measurement errors representing the gap between theoretical and empirical models. We estimate the model based on data for the German securities market and then the estimation results are employed to develop long-term bond investment strategies. Because of the presence of measurement errors, we provide a simulation study to examine the performance of the best theoretical investment strategy. We find that the measurement errors have a great impact on the optimality of the investment strategies and that under certain circumstance the best theoretical investmentstrategies may not perform so well in a real market situation. In the simulation study, we also investigate the role of information about the variability of the stochastic interest rate and the bond return dynamics. Our results show that this information can indeed be used to advantage in making sensible long-term investment decisions.
The defaultable forward rate is modelled as a jump diffusion process within the Schonbucher [26,27] general Heath, Jarrow and Morton [20] framework where jumps in the defaultable term structure fd(t, T) cause jumps and defaults to the defaultable bond prices Pd(t, T). Within this framework, we investigate an appropriate forward rate volatility structure that results in Markovian defaultable spot rate dynamics. In particular, we consider state dependent Wiener volatility functions and time dependent Poisson volatility functions. The corresponding term structures of interest rates are expressed as finite dimensional affine realizations in terms of benchmark defaultable forward rates In addition, we extend this model to incorporate stochastic spreads by allowing jump intensities to follow a square-root diffusion process. In that case the dynamics become non-Markovian and to restore path independence we propose either an approximate Markovian scheme or, alternatively, constant Poisson volatility functions. We also conduct some numerical simulations to gauge the effect of the stochastic intensity and the distributional implications of various volatility specifications.
Engel, A., Szidarovszky, F. & Chiarella, C. 2007, 'A Game Theoretical Coalition Model of International Fishing with Time Delay', Journal of Concrete and Applicable Mathematics, vol. 5, no. 2, pp. 115-131.
The oligopoly model of international fishing of Szidarovszky and Okuguchi [7] where the harvesting countries form a coalition is re- visited with the additional assumption that there is a time lag in obtaining and implementing information on the fish stock. The introduction of continuously distributed time lags results in a special Volterra-type integro-differential equation. Since it is equivalent to a system of nonlinear ordinary differential equations, linearization and standard techniques are used to examine the local asymptotic behavior of the equilibrium. Stability conditions are derived and in the case of instability special cyclic behavior is analyzed.
This paper examines the pricing of interest rate derivatives when the interest rate dynamics experience infrequent jump shocks modelled as a Poisson process. The pricing framework adapted was developed by Chiarella and Nikitopoulos to provide an extension of the Heath, Jarrow and Morton model to jump-diffusions and achieves Markovian structures under certain volatility specifications. Fourier Transform solutions for the price of a bond option under deterministic volatility specifications are derived and a control variate numerical method is developed under a more general state dependent volatility structure, a case in which closed form solutions are generally not possible. In doing so, a novel perspective is provided on control variate methods by going outside a given complex model to a simpler more tractable setting to provide the control variates.
Chiarella, C., Dieci, R. & He, X. 2007, 'Heterogeneous Expectations and Speculative Behavior in a Dynamic Multi-Asset Framework', Journal of Economic Behavior and Organization, vol. 62, no. 3, pp. 408-427.
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This paper develops a dynamic model of a financial market where heterogeneous agents invest among multiple risky assets and a risk-free asset, under a market maker scenario. Particular attention is paid to the case of two risky assets and two agent types, fundamentalists and trend chasers, whose beliefs on both first and second moments of the conditional distribution of returns are based on past observations. Conditions for the stability of the ?fundamental? equilibrium are established and the effect of the correlation between the risky assets is examined. It turns out that investors? anticipated correlation and dynamic portfolio diversification do not always have a stabilizing role, but rather may act as a source of complexity in the financial market.
Rothig, A. & Chiarella, C. 2007, 'Investigating Nonlinear Speculation in Cattle, Corn and Hog Futures Markets Using Logisitic Smooth Transition Regression Models', Journal Of Futures Markets, vol. 27, no. 8, pp. 719-737.
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This study explores nonlinearities in the response of speculators? trading activity to price changes in live cattle, corn, and lean hog futures markets Analyzing weekly data from March 4, 1997 through December 27, 2005, the authors reject linearity in all of these markets. Using smooth transition regression models, the authors found a similar structure of nonlinearities with regard to the number of different regimes, the choice of the transition variable, and the value at which the transition occurs.
Chiarella, C., He, X.Z. & Wang, D. 2006, 'A behavioral asset pricing model with a time-varying second moment', CHAOS SOLITONS & FRACTALS, vol. 29, no. 3, pp. 535-555.
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Chiarella, C., He, X.-.Z. & Hommes, C. 2006, 'Moving average rules as a source of market instability', PHYSICA A-STATISTICAL MECHANICS AND ITS APPLICATIONS, vol. 370, no. 1, pp. 12-17.
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Chiarella, C. & Hsiao, C. 2006, 'The impact of short-sale constraints on asset allocation strategies via the backward Markov chain approximation method', Computational Economics, vol. 28, no. 2, pp. 113-137.
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This paper considers an asset allocation strategy over a finite period under investment uncertainty and short-sale constraints as a continuous-time stochastic control problem. Investment uncertainty is characterised by a stochastic interest rate and inflation risk. If there are no short-sale constraints, the optimal asset allocation strategy can be obtained analytically. We consider several kinds of short-sale constraints and employ the backward Markov chain approximation method to explore the impact of short-sale constraints on asset allocation decisions. Our results show that the short-sale constraints do indeed have a significant impact on these decisions.
Asada, T., Chen, P., Chiarella, C. & Flaschel, P. 2006, 'Keynesian dynamics and the wage-price spiral: A baseline disequilibrium model', JOURNAL OF MACROECONOMICS, vol. 28, no. 1, pp. 90-130.
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Agliari, A., Chiarella, C. & Gardini, L. 2006, 'A re-evaluation of adaptive expectations in light of global nonlinear dynamic analysis', JOURNAL OF ECONOMIC BEHAVIOR & ORGANIZATION, vol. 60, no. 4, pp. 526-552.
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Chiarella, C., Dieci, R. & Gardini, L. 2006, 'Asset price and wealth dynamics in a financial market with heterogeneous agents', Journal of Economic Dynamics and Control, vol. 30, no. 9-10, pp. 1755-1786.
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This paper considers a discrete-time model of a financial market with one risky asset and one risk-free asset, where the asset price and wealth dynamics are determined by the interaction of two groups of agents, fundamentalists and chartists. In each per
Chiarella, C. 2006, 'My chaotic career - from billiard balls to economic dynamics and financial markets - Carl Chiarella', CHAOS SOLITONS & FRACTALS, vol. 29, no. 3, pp. 517-519.
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Chiarella, C. & Ziogas, A. 2006, 'A fourier transform analysis of the American call option on assets driven by jump-diffusion processes (QFRC paper #174)', Quantitative Finance Research Centre Working Paper Series, vol. 174.
Chen, P., Chiarella, C., Flaschel, P. & Semmler, W. 2006, 'Keynesian macrodynamics and the Phillips cuve: An estimated baseline macromodel for the US economy (F&E paper #147)', School of Finance & Economics Working Paper Series, vol. 147.
Chen, P., Chiarella, C., Flaschel, P. & Hung, H. 2006, 'Keynesian disequilibrium dynamics: Covergence roads to instability and the emergence of complex business (F&E paper #146)', School of Finance & Economics Working Paper Series, vol. 146.
Rothig, A. & Chiarella, C. 2006, 'Investigating non-linear speculation in cattle, corn and hog futures markets using logistics smooth transition regression models (CEM paper #101)', Centre for Empirical Macroeconomics, University of Bielefeld Working Paper Series, vol. 101.
Rothig, A. & Chiarella, C. 2006, 'Investigating non-linear speculation in cattle, corn and hog futures markets using logistics smooth transition regression models (IE paper #167)', Institute of Economics, Technical University of Darmstadt Working Paper Series, vol. 167.
Chiarella, C., Flaschel, P. & Hung, H. 2006, 'Interacting Business Cycle Fluctuations: A Two-Country Model', Singapore Economic Review, vol. 51, no. 3, pp. 365-394.
In this paper, we develop a model of business cycle fluctuations between two interacting open economies within the disequilibrium or non-market clearing paradigm. We analyze the main feedback mechanisms (Keynes, Mundell, Rose and Dornbusch) driving the dynamics and the conflict between their stabilizing and destabilizing tendencies and how these depend on certain key speeds of adjustment in the real and foreign exchange sectors. We explore numerically a variety of situations of interacting price cycles in the two countries, where the steady state is locally repelling, but where the overall dynamics are bounded in an economically meaningful domain by assuming downward money wage rigidity.
Bhar, R., Chiarella, C., Hung, H. & Runggaldier, W.J. 2006, 'The volatility of the instantaneous spot interest rate implied by arbitrage pricing - A dynamic Bayesian approach', AUTOMATICA, vol. 42, no. 8, pp. 1381-1393.
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Chen, P., Chiarella, C., Flaschel, P. & Semmler, W. 2006, 'The feedback channels in macroeconomics: analytical foundations for structural econometric model building', Central European Journal of Operations Research, vol. 14, no. 3, pp. 261-288.
We investigate important macroeconomic and macroeconometric feedback channels in models that concern the dynamic interaction of the labor market, product market and the monetary and financial sector. The core of our study is an applied disequilibrium model of monetary growth of a small open economy. After surveying the feedback channels we consider a compact description of the intensive form of the model. We consider various types of subsystems, the integration of which is subsequently compared from the perspective of bifurcation diagrams that separate cases of asymptotic stability from stable cyclical behavior as well as pure explosiveness. In this way we lay out a research strategy, which will show, in contrast to what is generally believed, that applied integrated macrodynamic systems can have a variety of interesting attractors and transient dynamics, which are obtained in particular when locally explosive situations are turned into bounded dynamics by the addition of specifically tailored extrinsic nonlinearities.
Chiarella, C., He, X.-.Z., Hung, H. & Zhu, P. 2006, 'An analysis of the cobweb model with boundedly rational heterogeneous producers', JOURNAL OF ECONOMIC BEHAVIOR & ORGANIZATION, vol. 61, no. 4, pp. 750-768.
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Chiarella, C., He, X. & Hommes, C. 2006, 'A dynamic analysis of moving average rules', Journal of Economic Dynamics and Control, vol. 30, no. 9-10, pp. 1729-1753.
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The use of various moving average (MA) rules remains popular with financial market practitioners. These rules have recently become the focus of a number empirical studies, but there have been very few studies of financial market models where some agents
Chiarella, C. & To, T. 2006, 'The multifactor nature of the volatility of futures markets', Computational Economics, vol. 27, no. 2-3, pp. 163-183.
This paper estimates a model of interest rate dynamics containing multi-factor Wiener and single-factor Poisson jump volatility components. Data from the highly liquid but short term futures markets are used. The difficult numerical problem of estimating such multi-factor models is resolved by using a genetic algorithm to carry out the optimization procedure. It is established that the multi-factor Wiener volatility components are adequate to model the interest rate dynamics without the need to incorporate Poisson jump components, the existence of which would create difficulties in the practical use of interest rate models.
Chiarella, C. & Ziogas, A. 2005, 'Evaluation of American strangles', Journal Of Economic Dynamics & Control, vol. 29, no. 1-2, pp. 31-62.
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This paper presents a generalisation of McKean's free boundary value problem for American options by considering an American strangle position, where exercising one side of the payoff early knocks-out the remaining side. The Fourier transform technique i
Chiarella, C. & Szidarovszky, F. 2005, 'On the stability of price-adjusting oligopolies with incomplete information', INTERNATIONAL JOURNAL OF SYSTEMS SCIENCE, vol. 36, no. 8, pp. 501-507.
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Chiarella, C., Dieci, R. & Gardini, L. 2005, 'The dynamic interaction of speculation and diversification', Applied Mathematical Finance, vol. 12, no. 1, pp. 17-52.
Chiarella, C. & Platen, E. 2005, 'Special issue: Introduction to Selected Proceedings from the Quantitative Methods in Finance 2004 Conference (QMF 2004)', QUANTITATIVE FINANCE, vol. 5, no. 3, pp. 235-235.
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Chiarella, C., Clewlow, L. & Musti, S. 2005, 'A volatility decomposition control variate technique for Monte Carlo simulations of Heath Jarrow Morton models', EUROPEAN JOURNAL OF OPERATIONAL RESEARCH, vol. 161, no. 2, pp. 325-336.
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Chiarella, C. & Szidarovszky, F. 2005, 'Cournot oligopolies with product differentiation under uncertainty', Computers & Mathematics With Applications, vol. 50, no. 38810, pp. 413-424.
This paper considers Cournot oligopolies with product differentiation when the firms have inexact knowledge of the price functions and there are random time lags in obtaining and implementing information on the firms' own outputs and prices as well as on
Bohm, V. & Chiarella, C. 2005, 'Mean variance preferences expectations formation and the dynamics of random asset prices', Mathematical Finance, vol. 15, no. 1, pp. 61-97.
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This paper analyzes the dynamics of an explicit random process of prices and price expectations of finitely many assets in an economy with overlapping generations of heterogeneous consumers. They maximize expected utility with respect to subjective trans
Szidarovszky, F., Engel, A. & Chiarella, C. 2004, 'A game theoretical model of international fishing with time delay.', International Game Theory Review, vol. 6, no. 3, pp. 391-415.
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Chiarella, C. & Gao, S. 2004, 'The value of the S&P 500 - a macro view of the stock market adjustment process.', Global Finance Journal, vol. 15, no. 2, pp. 171-196.
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Bischi, G., Chiarella, C. & Kopel, M.O. 2004, 'The long run outcomes and global dynamics of a duopoly game with misspecified demand functions.', International Game Theory Review, vol. 6, no. 3, pp. 343-379.
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Agliari, A., Chiarella, C. & Gardini, L. 2004, 'A stability analysis of the perfect foresight map in nonlinear models of monetary dynamics', CHAOS SOLITONS & FRACTALS, vol. 21, no. 2, pp. 371-386.
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Chiarella, C. & Szidarovszky, F. 2004, 'Dynamic oligopolies without full information and with continuously distributed time lags', JOURNAL OF ECONOMIC BEHAVIOR & ORGANIZATION, vol. 54, no. 4, pp. 495-511.
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Szidarovszky, F. & Chiarella, C. 2004, 'The asymptotic behavior of dynamic producer-consumer systems', MATHEMATICAL AND COMPUTER MODELLING, vol. 39, no. 11-12, pp. 1297-1312.
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Bhar, R., Chiarella, C. & Runggaldier, W.J. 2004, 'Inferring the forward looking equity risk premium from derivative prices', STUDIES IN NONLINEAR DYNAMICS AND ECONOMETRICS, vol. 8, no. 1.
Engel, A., Szidarovszky, F. & Chiarella, C. 2003, 'A game theoretical partially cooperative model of international fishing with time delay', CHAOS SOLITONS & FRACTALS, vol. 18, no. 3, pp. 549-560.
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Chiarella, C. & Szidarovszky, F. 2003, 'Bounded continuously distributed delays in dynamic oligopolies', CHAOS SOLITONS & FRACTALS, vol. 18, no. 5, pp. 977-993.
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Chiarella, C. & He, X. 2003, 'Heterogeneous beliefs, risk, and learning in a simple asset-pricing model with a market maker', Macroeconomic Dynamics, vol. 7, no. 4, pp. 503-536.
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Chiarella, C., Flaschel, P., Gong, G. & Semmler, W. 2003, 'Nonlinear Phillips curves, complex dynamics and monetary policy in a Keynesian macro model', CHAOS SOLITONS & FRACTALS, vol. 18, no. 3, pp. 613-634.
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Chiarella, C. & To, T. 2003, 'The jump component of the volatility structure of interest rate futures markets: an international comparison', Journal Of Futures Markets, vol. 23, no. 12, pp. 1125-1158.
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Chiarella, C. & Szidarovszky, F. 2003, 'Dynamic oligopolies with pollution treatment cost sharing', Keio Economics Studies, vol. XL, no. 1, pp. 27-44.
Chiarella, C., Flaschel, P., Groh, G. & Semmler, W. 2003, 'Reply to K. Velupillai's review of Chiarella and Flaschel: The dynamics of Keynesian monetary growth: Macro foundations (CF), and Chiarella, Flaschel, Groh and Semmler: Disequilibrium, growth and labor market dynamics: Macro perspectives (CFGS) - Introduction: The historical perspective', JOURNAL OF ECONOMICS-ZEITSCHRIFT FUR NATIONALOKONOMIE, vol. 78, no. 1, pp. 96-104.
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Chiarella, C., Gallegati, M., Leombruni, R. & Palestrini, A. 2003, 'Asset price dynamics among heterogeneous interacting agents', Computational Economics, vol. 22, no. 2-3, pp. 213-223.
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Chiarella, C. & He, X.Z. 2003, 'Dynamics of beliefs and learning under a(L)-processes - the heterogeneous case', JOURNAL OF ECONOMIC DYNAMICS & CONTROL, vol. 27, no. 3, pp. 503-531.
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Chiarella, C. & Kwon, O. 2003, 'Finite dimensional affine realisation of HJM models in terms of forward rates and yields', Review of Derivatives Research, vol. 6, no. 2, pp. 129-155.
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Chiarella, C. & Platen, E. 2003, 'Introduction To Selected Proceedings From Quantitative Methods In Finance 2002', Quantitative Finance, vol. 3, no. 1, pp. 0-0.
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Li, W.Y., Rychlik, M., Szidarovszky, F. & Chiarella, C. 2003, 'On the attractivity of a class of homogeneous dynamic economic systems', NONLINEAR ANALYSIS-THEORY METHODS & APPLICATIONS, vol. 52, no. 6, pp. 1617-1636.
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This paper considers a class of term structure models that is a parameterisation of the Shirakawa (1991) extension of the Heath et al. (1992) model to the case of jump-diffusions. We consider specific forward rate volatility structures that incorporate state dependent Wiener volatility functions and time dependent Poisson volatility functions. Within this framework, we discuss the Markovianisation issue, and obtain the corresponding affine term structure of interest rates. As a result we are able to obtain a broad tractable class of jump-diffusion term structure models. We relate our approach to the existing class of jump-diffusion term structure models whose starting point is a jump-diffusion process for the spot rate. In particular we obtain natural jump-diffusion versions of the Hull and White (1990, 1994) one-factor and two-factor models and the Ritchken and Sankarasubramanian (1995) model within the HJM framework. We also give some numerical simulations to gauge the effect of the jump-component on yield curves and the implications of various volatility specifications for the spot rate distribution.
Chiarella, C. & He, X. 2002, 'Heterogeneous beliefs, risk and learning in a simple asset pricing model', Computational Economics, vol. 19, no. 1, pp. 95-132.
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Chiarella, C. & Szidarovszky, F. 2002, 'The asymptotic behavior of dynamic rent-seeking games', COMPUTERS & MATHEMATICS WITH APPLICATIONS, vol. 43, no. 1-2, pp. 169-178.
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Chiarella, C. & Iori, G. 2002, 'A simulation analysis of the microstructure of double auction markets', Quantative Finance, vol. 2, no. 5, pp. 346-353.
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Chiarella, C., Semmler, W., Mittnik, S. & Zhu, P. 2002, 'Stock market, interest rate and output: a model and estimation for US time series data', Studies in NonLinear Dynamics and Econometrics, vol. 6, no. 1 / Article 2, pp. 1-37.
Stock market, interest rate and output: a model and estimation for US time series data
Chiarella, C., Dieci, R. & Gardini, L. 2002, 'Speculative behaviour and complex asset price dynamics: a global analysis', JOURNAL OF ECONOMIC BEHAVIOR & ORGANIZATION, vol. 49, no. 2, pp. 173-197.
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Chiarella, C. 2002, 'Attractors, bifurcations, and chaos. Nonlinear phenomena in economics.', JOURNAL OF ECONOMICS-ZEITSCHRIFT FUR NATIONALOKONOMIE, vol. 75, no. 2, pp. 186-189.
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Chiarella, C. & Kwon, O. 2001, 'Classes of Interest Rate Models Under the HJM Framework', Asia-Pacific Financial Markets, vol. 8, no. 1, pp. 1-22.
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Chiarella, C., Flaschel, P., Franke, R. & Semmler, W. 2001, 'Output Interest & the Stock Market: An Alternative to the Jump Variable Technique', The Bulletin of the Czech Econometric Society, vol. 7, no. 13, pp. 1-29.
Szidarovszky, F. & Chiarella, C. 2001, 'Dynamic Oligopilies, Stability & Bifurcation', CUBO Matematica Educational, vol. 3, no. 2, pp. 269-284.
Chiarella, C., Dieci, R. & Gardini, L. 2001, 'Asset price dynamics in a financial market with fundamentalists and chartists', DISCRETE DYNAMICS IN NATURE AND SOCIETY, vol. 6, no. 2, pp. 69-+.
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Chiarella, C., Pasquali, S. & Runggaldier, W.J. 2001, 'On filtering in Markovian term structure models: An approximation approach', ADVANCES IN APPLIED PROBABILITY, vol. 33, no. 4, pp. 794-809.
Chiarella, C. & He, X. 2001, 'Asset Price & Wealth Dynamics Under Heterogeneous Expectations', Quantitative Finance, vol. 1, no. 5, pp. 509-526.
Chiarella, C. & Szidarovszky, F. 2001, 'The Nonlinear Cournot Model Under Uncertainty with Continously Distributed Time Lags', Central European Journal of Operational Research, vol. 9, pp. 183-196.
Chiarella, C., Flaschel, P. & Semmler, W. 2001, 'Price Flexibility & Debt Dynamics in a High Order AS-AD Model', Central European Journal of Operational Research, vol. 9, no. 1-29, pp. 119-145.
Bhar, R., Chiarella, C. & Pham, T.M. 2001, 'Modelling the currency forward risk premium: A new perspective', Asia Pacific Financial Markets, vol. 8, no. 4, pp. 341-360.
In this paper we seek to develop a new approach to the time series analysis of foreign exchange risk premia. We do so by assuming a geometric Brownian process for the spot exchange rate and expressing the no-arbitrage spot-forward price relationship under the historical probability measure. We are thereby able to obtain a stochastic differential equation system linking the spot exchange rate, the forward exchange rate and the risk premium (modelled directly as a mean-reverting diffusion process) which we estimate using Kalman filtering techniques. We are able to use observations at a range of frequencies since the framework we set up does not involve overlapping observations. The model is then applied to the French Franc/USD, DEM/USD, GBP/USD, and Japanese Yen/USD exchange rates from 1 January 1990 to 31 December 1998. For all currencies we find evidence that the forward risk premium is stationary and exhibits substantial positive time variation
Chiarella, C. & Kwon, O. 2001, 'Forward Rate Dependent Markovian Transformation of the Heath-Jarrow-Morton Term Structure Model', Finance & Stochastics, vol. 5, no. 2, pp. 237-257.
In this paper, a class of forward rate dependent Markovian transformations of the Heath-Jarrow-Morton [16] term structure model are obtained by considering volatility processes that are solutions of linear ordinary differential equations. These transformations generalise the Markovian systems obtained by Carverhill [8], Ritchken and Sankarasubramanian [20], Bhar and Chiarella [1], and Inui and Kijima [18], and also generalise the bond price formulae obtained therein.
Bhar, R. & Chiarella, C. 2000, 'Expectations in monetary policy in Australia implied by the probability distributions of interest rate derivatives', The European Journal of Finance, vol. 6, no. 2, pp. 113-125.
Chiarella, C. & Kwon, O. 2000, 'A complete Markovian stochastic volatility model in the HJM framework', Asia-Pacific Financial Markets, vol. 7, no. 4, pp. 293-304.
Chiarella, C. & Flaschel, P. 2000, 'High order disequilibrium growth dynamics: Theoretical aspects and numerical features', JOURNAL OF ECONOMIC DYNAMICS & CONTROL, vol. 24, no. 5-7, pp. 935-963.
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Bhar, R., Chiarella, C., El-Hassan, N. & Zheng, X. 2000, 'Reduction of forward rate dependent HJM models to Markovian form: pricing European bond options', Journal of Computational Finance, vol. 3, no. 3, pp. 47-72.
Chiarella, C. & Khomin, P. 1999, 'Adaptively evolving expectations in models of monetary dynamics: The fundamentalists forward looking', ANNALS OF OPERATIONS RESEARCH, vol. 89, pp. 21-34.
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Chiarella, C., El-Hassan, N. & Kucera, A. 1999, 'Evaluation of American option prices in a path integral framework using Fourier-Hermite series expansions', JOURNAL OF ECONOMIC DYNAMICS & CONTROL, vol. 23, no. 9-10, pp. 1387-1424.
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Chiarella, C. & Flaschel, P. 1999, 'Keynesian monetary growth dynamics in open economies', ANNALS OF OPERATIONS RESEARCH, vol. 89, pp. 35-59.
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Chiarella, C. & Flaschel, P. 1998, 'Dynamics of natural rates of growth and employment', MACROECONOMIC DYNAMICS, vol. 2, no. 3, pp. 345-368.
Chiarella, C. & Vlacic, L. 1997, 'Preface to the special section on modelling and control of national and regional economies', CONTROL ENGINEERING PRACTICE, vol. 5, no. 4, pp. 517-518.
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Chiarella, C. & El-Hassan, N. 1997, 'Evaluation of derivative security prices in the Heath-Jarrow-Morton framework as path integrals using fast fourier transform techniques', Journal of Financial Engineering, vol. 6, no. 2, pp. 121-147.
Chiarella, C. & Khomin, A. 1996, 'An analysis of the complex dynamic behaviour of nonlinear oligopoly models with time delays', CHAOS SOLITONS & FRACTALS, vol. 7, no. 12, pp. 2049-2065.
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Chiarella, C. 1996, 'Business cycles: Theory and empirical methods .8 - Semmler,W', JOURNAL OF ECONOMICS-ZEITSCHRIFT FUR NATIONALOKONOMIE, vol. 63, no. 2, pp. 224-227.
Chiarella, C. & Flaschel, P. 1996, 'Real and monetary cycles in models of Keynes-Wicksell type', JOURNAL OF ECONOMIC BEHAVIOR & ORGANIZATION, vol. 30, no. 3, pp. 327-351.
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Chiarella, C. & Flaschel, P. 1996, 'An integrative approach to 2D-macromodels of growth, price and inventory dynamics', CHAOS SOLITONS & FRACTALS, vol. 7, no. 12, pp. 2105-2133.
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Chiarella, C. & El-Hassan, N. 1996, 'A preference free partial differential equation for the term structure of interest rates', Financial Engineering and the Japanese Markets, vol. 3, no. 4, pp. 217-238.
CHIARELLA, C. 1995, 'NONLINEAR DYNAMICS AND EVOLUTIONARY ECONOMICS - DAY,RH, CHEN,P', ECONOMIC RECORD, vol. 71, no. 214, pp. 303-305.
CHIARELLA, C. 1992, 'ECONOMIC-DYNAMICS - ZHANG,WB', JOURNAL OF ECONOMIC BEHAVIOR & ORGANIZATION, vol. 18, no. 3, pp. 443-445.
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CHIARELLA, C., KEMP, M. & VANLONG, N. 1989, 'INNOVATION AND THE TRANSFER OF TECHNOLOGY - A LEADER-FOLLOWER MODEL', ECONOMIC MODELLING, vol. 6, no. 4, pp. 452-456.
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CHIARELLA, C. 1988, 'THE COBWEB MODEL - ITS INSTABILITY AND THE ONSET OF CHAOS', ECONOMIC MODELLING, vol. 5, no. 4, pp. 377-384.
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CHIARELLA, C. & SHANNON, A.G. 1986, 'AN EXAMPLE OF DIABETES COMPARTMENT MODELING', MATHEMATICAL MODELLING, vol. 7, no. 9-12, pp. 1239-1244.
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CHIARELLA, C. 1986, 'PERFECT FORESIGHT MODELS AND THE DYNAMIC INSTABILITY PROBLEM FROM A HIGHER VIEWPOINT', ECONOMIC MODELLING, vol. 3, no. 4, pp. 283-292.
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CHIARELLA, C., KEMP, M., VANLONG, N. & OKUGUCHI, K. 1984, 'ON THE ECONOMICS OF INTERNATIONAL FISHERIES', INTERNATIONAL ECONOMIC REVIEW, vol. 25, no. 1, pp. 85-92.
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Other
Cheang, G.H.L., Chiarella, C. & Ziogas, A. 2013, 'The representation of American options prices under stochastic volatility and jump-diffusion dynamics'.
Chiarella, C., He, X.-.Z. & Pellizzari, P. 2012, 'A DYNAMIC ANALYSIS OF THE MICROSTRUCTURE OF MOVING AVERAGE RULES IN A DOUBLE AUCTION MARKET'.
Chiarella, C., Fanelli, V. & Musti, S. 2011, 'Modelling the evolution of credit spreads using the Cox process within the HJM framework A CDS option pricing model'.
Cheang, G.H. & Chiarella, C. 2011, 'A modern view on Merton's jump-diffusion model', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 287 Abstract: erton has provided a formula for the price of a European call option on a single stock where the stock price process contains a continuous Poisson jump component, in addition to a continuous log-normally distributed component. In Merton's analysis, the jump-risk is not priced. Thus the distribution of the jump-arrivals and the jump-sizes do not change under the change of measure. We go onto introduce a Radon-Nikodym derivative process that induces the change of measure from the market measure to an equivalent martingale measure. The choice of parameters in the Radon-Nikodym derivative allows us to price the option under different financial-economic scenarios. We introduce a hedging argument that eliminates the jump-risk in some sort of averaged sense, and derive an integro-partial differential equation of the option price that is related to the one obtained by Merton.
Chiarella, C., Kang, B. & Meyer, G. 2010, 'The evaluation of barrier option prices under stochastic volatility', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 266 Abstract: This paperc onsiders the problem o fnumerically evaluating barrier option prices when the dynamics of the underlying are driven by stochastic volatility following the square root process of Heston (1993). We develop a method of lines approach to evaluate the price as well as the delta and gamma of the option. The method is able to effciently handle bothc ontinuously monitored and discretely monitored barrier options and can also handle barrier options with early exercise features. In the latter case, we can calculate the early exercise boundary of an American barrier option in both the continuously and discretely monitored cases.
Chiarella, C., Hung, H. & Flaschel, P. 2010, 'Keynesian disequilibrium dynamics: Estimated convergence, roads to instability and the emergence of complex business fluctuations', QFRC Research Paper.
We reformulate the traditional AS-AD growth model of the Neoclassical Synthesis (stage I) with a Taylor policy rule replacing the conventional LM-curve, with gradually adjusting wages as well as prices, and with perfect foresight on current inflation rates and an adaptively revised notion of an inflationary climate in which the economy is operating. We compare this approach with the New Keynesian approach, the Neoclassical Synthesis, stage II, with staggered price and wage setting and find various common components, yet with radically different dynamic implications due to our treatment of the forward-looking part of our wage-price spiral. We show for a system estimate of our model that it implies qualitatively local asymptotic stability and when its estimated form is simulated in response to isolated shocks strongly damped business fluctuations, due to a stable interaction of goods market dynamics with the interest rate policy of the central bank and due to a normal working of a real-wage feedback chain. These results are however endangered leading in fact to economic breakdown when there is a global floor to money wage inflation rates. In this case, the return of some money wage flexibility in deep depressions is of help in restoring viability of the model, thereby even avoiding explosive dynamics and the collapse of the economy. This situation leads to viable, but complex business fluctuations
Chiarella, C., Maina, S.C. & Nikitopoulos Sklibosios, C. 2010, 'Markovian Defaultable HJM Term Structure Models with Unspanned Stochastic Volatility', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 283 <p>Abstract: This paper presents a class of defaultable term structure models within the HJM framework with stochastic volatility. Under certain volatility speci?cations, the model admits ?nite dimensional Markovian structures and consequently provides tractable solutions for defaultable bond prices. Furthermore, a bond pricing formula is obtained in terms of market observable quantities, speci?cally in terms of discrete tenor forward rates. The effect of stochastic volatility and of correlations between the stochastic volatility, defaultable short rate and credit spreads on the defaultable bond prices and returns is also investigated.
Chiarella, C., Iori, G. & Perello, J. 2009, 'The impact of heterogeneous trading rules on the limit order book and order flows'.
Chiarella, C., He, X. & Zheng, M. 2009, 'Heterogeneous Expectations and Exchange Rate Dynamics (243)', Quantitative Finance Research Paper Series.
This paper presents a continuous-time model of exchange rates relying not only on macroeconomic factors but also having a market microstructure component. The driving macroeconomic factor is the interest rate differential, while the market microstructure element is described by the expectations of boundedly rational portfolio managers who use a weighted average of the expectations of fundamentalists and chartists. Within this framework, the different roles of the macroeconomic factors and market microstructure elements on the determination of the exchange rate are examined explicitly. We show that this simple model generates very complicated market behaviour, including the existence of multiple steady state equilibria, the deviations of the market exchange rate from the fundamental, and market fluctuations. Numerical simulation of the corresponding stochastic version of the model shows that the model is able to generate typical time series and volatility clustering patterns observed in exchange rate markets.
Chiarella, C. & Kang, B. 2009, 'The Evaluation of American Compound Option Prices Under Stochastic Volatility Using the Sparse Grid Approach (245)', Quantitative Finance Research Paper Series.
A compound option (the mother option) gives the holder the right, but not obligation to buy (long) or sell (short) the underlying option (the daughter option). In this paper, we demonstrate a partial differential equation (PDE) approach to pricing American-type compound options where the underlying dynamics follow Hestons stochastic volatility model. This price is formulated as the solution to a two-pass free boundary PDE problem. A modified sparse grid approach is implemented to solve the PDEs, which is shown to be accurate and efficient compared with the results from Monte Carlo simulation combined with the Method of Lines.
Chiarella, C., Kang, B., Meyer, G. & Ziogas, A. 2009, 'The Evaluation of American Option Prices Under Stochastic Volatility and Jump-Diffusion Dynamics Using the Method of Lines (219)', Quantitative Finance Research Paper Series.
This paper considers the problem of numerically evaluating American option prices when the dynamics of the underlying are driven by both stochastic volatility following the square root process of Heston (1993), and by a Poisson jump process of the type originally introduced by Merton (1976). We develop a method of lines algorithm to evaluate the price as well as the delta and gamma of the option, thereby extending the method developed by Meyer (1998) for the case of jump-diffusion dynamics. The accuracy of the method is tested against two numerical methods that directly solve the integro-partial differential pricing equation. The first is an extension to the jump-diffusion situation of the componentwise splitting method of Ikonen & Toivanen (2007). The second method is a Crank-Nicolson scheme that is solved using projected successive over relaxation which is taken as the benchmark. The relative efficiency of these methods for computing the American call option price, delta, gamma and free boundary is analysed. If one seeks an algorithm that gives not only the price but also the delta and gamma to the same level of accuracy for a given computational effort then the method of lines seems to perform best amongst the methods considered.
Chiarella, C., Iori, G. & Perello, J. 2009, 'The impact of heterogeneous trading rules on the limit order book and order flows', Discussion Paper Series, Department of Economics, City University, London.
Discussion Paper Number: 08/04 <p>Abstract: In this paper we develop a model of an order-driven market where traders set bids and asks and post market or limit orders according to exogenously fixed rules. Agents are assumed to have three components to the expectation of future asset returns, namely-fundamentalist, chartist and noise trader. Furthermore agents differ in the characteristics describing these components, such as time horizon, risk aversion and the weights given to the various components. The model developed here extends a great deal of earlier literature in that the order submissions of agents are determined by utility maximisation, rather than the mechanical unit order size that is commonly assumed. In this way the order flow is better related to the ongoing evolution of the market. For the given market structure we analyze the impact of the three components of the trading strategies on the statistical properties of prices and order flows and observe that it is the chartist strategy that is mainly responsible of the fat tails and clustering in the artificial price data generated by the model. The paper provides further evidence that large price changes are likely to be generated by the presence of large gaps in the book.
Chiarella, C., Clewlow, L. & Kang, B. 2009, 'Modelling and estimating the forward price curve in the energy market', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 260 Abstract: The stochastic or random nature of commodity prices plays a central role in models for valuing ?nancial contingent claims on commodities. In this paper, by enhancing a multifactor framework which is consistent not only with the market observable forward price curve but also the volatilities and correlations of forward prices, we propose a two factor stochastic volatility model for the evolution of the gas forward curve. The volatility is stochastic due to a hidden Markov Chain that causes it to switch between on peak? and off peak? states. Based on the structure functional forms for the volatility, we propose and implement the Markov Chain Monte Carlo (MCMC) method to estimate the parameters of the forward curve model. Applications to simulated data indicate that the proposed algorithm is able to accommodate more general features, such as regimes witching and seasonality. Applications to the market gas forward data shows that the MCMC approach provides stable estimates.
Chiarella, C., Dieci, R. & He, X. 2009, 'A framework for CAPM with heterogenous beliefs', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 254 Abstract: We introduce heterogeneous beliefs in to the mean-variance framework of the standard CAPM, in contrast to the standard approach which assumes homogeneous beliefs. By assuming that agents form optimal portfolios based upon their heterogeneous beliefs about conditional means and covariances of the risky asset returns, we set up a framework for the CAPM that incorporates the heterogeneous beliefs when the market is in equilibrium. In this framework we first construct a consensus belief (with respect to the means and covariances of the risky asset returns) to represent the aggregate market belief when the market is in equilibrium. We then extend the analysis to a repeated one-period set-up and establish a framework for a dynamic CAPM using a market fraction model in which agents are grouped according to their beliefs. The exact relation between heterogeneous beliefs, the market equilibrium returns and the ex-ante beta-coeffcients is obtained. CAPM and Heterogeneous beliefs.
Chiarella, C., Dieci, R. & He, X. 2008, 'Heterogeneity, Market Mechanisms, and Asset Price Dynamics', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydnet.
Research Paper Number: 231 Abstract: This chapter surveys the boundedly rational heterogeneous agent (BRHA) models of financial markets, to the development of which the authors and several co-authors have contributed in various papers. We give particular emphasis to role of the market clearing mechanism used, the utility function of the investors, the interaction of price and wealth dynamics, portfolio implications, the impact of stochastic elements on the markets dynamics, and calibration of this class of models. Due to agents behavioural features and market noise, the BRHA models are both nonlinear and stochastic. We show that the BRHA models produce both a locally stable fundamental equilibrium corresponding to that of standard paradigm, as well as instability with a consequent rich range of possible complex behaviours characterised both indirectly by simulation and directly by stochastic bifurcations. A calibrated model is able to reproduce quite well the stylized facts of financial markets. The BRHA framework is thus able to accommodate market features that seem not easily reconcilable for the standard financial market paradigm, such as fat tail, volatility clustering, large excursions from the fundamental and bubbles.
Chiarella, C. & Cheang, G.H. 2008, 'Hedge portfolios in markets with price discontinuities', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 218 Abstract: We consider a market consisting of multiple assets under jump-diffusion dynamics with European style options written on these assets. It is well-known that such markets are incomplete in the Harrison and Pliska sense. We derive a pricing relation by adopting a Radon-Nikodym derivative based on the exponential martingale of a correlated Brownian motion process and a multivariate compound Poisson process. The parameters in the Radon-Nikodym derivative define a family of equivalent martingale measures in the model, and we derive the corresponding integro-partial differential equation for the option price. We also derive the pricing relation by setting up a hedge portfolio containing an appropriate number of options to "complete" the market. The market prices of jump-risks are priced in the hedge portfolio and we relate these to the choice of the parameters in the Radon-Nikodym derivative used in the alternative derivation of the integro-partial differential equation.
Cheang, G.H. & Chiarella, C. 2008, 'Exchange options under jump-diffusion dynamics', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 235 Abstract: Margrabe provides a pricing formula for an exchange option where the distributions of both stock prices are log-normal with correlated Wiener components. Merton has provided a formula for the price of a European call option on a single stock where the stock price process contains a continuous Poisson jump component, in addition to a continuous log-normally distributed component. We use Mertons analysis to extend Margrabes results to the case of exchange options where both stock price processes also contain compound Poisson jump components. A Radon-Nikodym derivative process that induces the change of measure from the market measure to an equivalent martingale measure is introduced. The choice of parameters in the Radon-Nikodym derivative allows us to price the option under different financial-economic scenarios. We also consider American style exchange options and provide a probabilistic intepretation of the early exercise premium.
Chiarella, C., Dieci, R. & He, X.-.Z. 2007, 'Heterogeneous expectations and speculative behavior in a dynamic multi-asset framework'.
Chiarella, C., He, X. & Zheng, M. 2007, 'The Stochastic Dynamics of Speculative Prices (208)', Quantitative Finance Research Paper Series.
Within the framework of the heterogeneous agent paradigm, we establish a stochastic model of speculative price dynamics involving of two types of agents, fundamentalists and chartists, and the market price equilibria of which can be characterised by the invariant measures of a random dynamical system. By conducting a stochastic bifurcation analysis, we examine the market impact of speculative behaviour. We show that, when the chartists use lagged price trends to form their expectations, the market equilibrium price can be characterised by a unique and stable invariant measure when the activity of the speculators is below a certain critical value. If this threshold is surpassed, the market equilibrium can be characterised by more than two invariant measures, of which one is completely stable, another is completely unstable and the remaining ones may exhibit various types of stability. Also, the corresponding stationary measure displays a significant qualitative change near the threshold value. We show that the stochastic model displays behaviour consistent with that of the underlying deterministic model. However, when the time lag in the formation of the price trends used by the chartists approaches zero, such consistency breaks down. In addition, the change in the stationary distribution is consistent with a number of market anomalies and stylised facts observed in financial markets, including a bimodal logarithmic price distribution and fat tails.
Chiarella, C., Hsiao, C. & Semmler, W. 2007, 'Intertemporal investment strategies under inflation risk', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 192 Abstract: This paper studies intertemporal investment strategies under inflation risk by extending the intertemporal framework of Merton (1973) to include a stochastic price index. The stochastic price index gives rise to a two-tier evaluation system: agents maximize their utility of consumption in real terms while investment activities and wealth evolution are evaluated in nominal terms. We include inflation-indexed bonds in the agents investment opportunity set and study their effectiveness in hedging against inflation risk. A new multifactor term structure model is developed to price both inflation-indexed bonds and nominal bonds, and the optimal rules for intertemporal portfolio allocation, both with and without inflation-indexed bonds are obtained in closed form. The theoretical model is estimated using data of US bond yield, both real and nominal, and S&P 500 index. The estimation results are employed to construct the optimal investment strategy for an actual real market situation. Wachter (2003) pointed out that without inflation risk, the most risk averse agents (with an infinite risk aversion parameter) will invest all their wealth in the long term nominal bond maturing at the end of the investment horizon. We extend this result to the case with inflation risk and conclude that the most risk averse agents will now invest all their wealth in the inflation-indexed bond maturing at the end of the investment horizon.
Chiarella, C. & Platen, E. 2007, 'The history of the Quantitative Methods in Finance Conference Series. 1992-2007', Research Paper Series, Qunatitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 207 Abstract: This report charts the history of the Quantitative Methods in Finance (QMF) conference from its beginning in 1993 to the 15th conference in 2007. It lists alphabetically the 1037 speakers who presented at all 15 conferences and the titles of their papers.
Chiarella, C., Dieci, R. & Gardini, L. 2006, 'Asset price and wealth dynamics in a financial market with heterogeneous agents'.
Chiarella, C. & He, X. 2006, 'Aggregation of heterogeneous beliefs and asset pricing theory: A mean-variance analysis', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Paper Number: 186
Chiarella, C. & Ziogas, A. 2006, 'American call options on jump-diffusion processes: A Fourier transform approach', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 174 Abstract: This paper considers the Fourier transform approach to derive the implicit integral equation for the price of an American call option in the case where the underlying asset follows a jump-diffusion process. Using the method of Jamshidian (1992), we demonstrate that the call option price is given by the solution to an inhomogeneous integro-partial differential equation in an unbounded domain, and subsequently derive the solution using Fourier transforms. We also extend McKeans incomplete Fourier transform approach to solve the free boundary problem under Mertons framework, for a general jump size distribution. We show how the two methods are related to each other, and also to the Geske-Johnson compound option approach used by Gukhal (2001). The paper also derives results concerning the limit for the free boundary at expiry, and presents a numerical algorithm for solving the linked integral equation system for the American call price, delta and early exercise boundary. This scheme is applied to Mertons jump-diffusion model, where the jumps are log-normally distributed.
Rothig, A. & Chiarella, C. 2006, 'Investigating nonlinear speculation in cattle, corn and hog futures markets using logistic smooth transition regression models', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 172 Abstract: This article explores nonlinearities in the response of speculators trading activity to price changes in live cattle, corn, and lean hog futures markets. Analyzing weekly data from March 4, 1997 to December 27, 2005, we reject linearity in all of these markets. Using smooth transition regression models, we find a similar structure of nonlinearities with regard to the number of different regimes, the choice of the transition variable, and the value at which the transition occurs.
Chiarella, C., Hung, H. & To, T. 2005, 'The volatility structure of the fixed income market under the HJM framework: a non-linear filtering approach (QFRC paper #151)'.
ISSN 1441-8010 www.business.uts.edu.au/qfrc/research/research_papers/rp151.pdf
ISSN 1441-8010 www.business.uts.edu.au/qfrc/research/research_papers/rp167.pdf
Chiarella, C. & To, T. 2005, 'The multifactor nature of the volatility of the Eurodollar futures market (QFRC paper #150)'.
ISSN 1441-8010 www.business.uts.edu.au/qfrc/research/research_papers/rp150.pdf
Chiarella, C. & Ziogas, A. 2005, 'Pricing American options on jump-diffusion processes using Fourier Hermite series expansions (QFRC paper #145)'.
ISSN 1441-8010 www.business.uts.edu.au/qfrc/research/research_papers/rp145.pdf
Chiarella, C. & Hsiao, C. 2005, 'The impact of short-sale constraints on asset allocation strategies via the backward Markov chain approximation method', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 171 Abstract: This paper considers an asset allocation strategy over a finite period under investment uncertainty and short-sale constraints as a continuous time stochastic control problem. Investment uncertainty is characterised by a stochastic interest rate and inflation risk. If there are no short-sale constraints, the optimal asset allocation strategy can be solved analytically. We consider several kinds of short-sale constraints and employ the backward Markov chain approximation method to explore the impact of short-sale constraints on asset allocation decisions. Our results show that the short-sale constraints do indeed have a significant impact on the asset allocation decisions.
Asada, T., Chen, P., Chiarella, C. & Flaschel, P. 2004, 'Keynesian dynamics and the wage price spiral: a baseline disequilibrium approach (Centre for Empirical Macroeconomics, University of Bielefeld, paper #69)'.
Bhar, R., Chiarella, C., Hung, H. & Runggaldier, W.J. 2004, 'The volatility of the instantaneous spot interest rate implied by arbitrage pricing - a dynamic Bayesian approach (School of Banking & Finance, UNSW, paper #2004-6)'.
Bhar, R., Chiarella, C. & To, T. 2004, 'Estimating the volatility structure of an arbitrage-free interest rate model via the futures markets (School of Banking & Finance, UNSW, paper #2004-5)'.
Chiarella, C., El-Hassan, N. & Kucera, A. 2004, 'Evaluation of point barrier options in a path integral framework using fourier-hermic expansion (QFRC paper #126)'.
Chiarella, C., He, X. & Hommes, C. 2004, 'A dynamic analysis of moving average rules (QFRC paper #133)'.
Chiarella, C., Kucera, A. & Ziogas, A. 2004, 'A survey of the integral representation of American option prices (QFRC paper #118)'.
Chiarella, C. & Ziogas, A. 2004, 'Mckean's methods applied to American option prices (QFRC paper #117)'.
Hsiao, C., Chiarella, C. & Semmler, W. 2004, 'Strategic asset allocation with arbitrage-free bond market using dynamic programing (Centre for Empirical MacroEconomics, University of Bielefeld, paper #76)'.
Chiarella, C., He, X. & Hommes, C. 2004, 'A dynamic analysis of moving average rules (Centre for Nonlinear Dynamics in Economics & Finance, University of Amsterdam, paper #04-14)', 10th International conference on computing in economics and finance.
Chiarella, C., He, X. & Wang, D. 2004, 'Statistical Properties of a Heterogeneous Asset Price Model with Time-Varying Second Moment', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 142 Abstract: Stability and bifurcation analysis of deterministic systems has been widely used in modeling financial markets. However, the impact of such dynamic phenomena on various statistical properties of the corresponding stochastic model, including skewness and excess kurtosis, various autocorrelation (AC) patterns of under and over reactions, and volatility clustering characterised by the long-range dependence of ACs, is not clear and has been very little studied. This paper aims to study this issue. Through a simple behavioural asset pricing model with fundamentalists and chartists, we examine the statistical properties of the model and their connection to the dynamics of the underlying deterministic model. In particular, our analysis leads to some insights into the type of mechanism that may be generating some of the stylised facts, such as fat tails, skewness, high kurtosis and long memory, observed in high frequency financial data.
Chiarella, C., He, X. & Wang, D. 2004, 'A behavioural asset pricing model with a time-varying second moment', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 141 Abstract: We develop a simple behavioural asset pricing model with fundamentalists and chartists to study price behaviour in financial markets. Within our model, the market impact of the weighting process of the conditional mean and variance of the chartists and investors' reactions are analysed. Price dynamics of the deterministic model under/over-reactions are analyzed. It shows different price dynamics and routes to complicated price behaviour when the chartists act as either trend followers or contrarians. It is found that (in a separate paper Chiarella et al (2004)) this analysis can be used to establish some connections between the statistical properties of the nonlinear stochastic system (such as distribution density and autocorrelation patterns of returns, in particular the stylised facts, such as fat tails, skewness, high kurtosis and long memory, observed in high frequency financial data) and the stability and bifurcation of the underlying deterministic system are established.
Asada, T., Chiarella, C. & Flaschel, P. 2003, 'Keynes-Metzler-Goodwin model building: the closed economy (F&E paper #124)'.
Asada, T., Chiarella, C., Flaschel, P. & Franke, R. 2003, 'Interacting two-country business fluctuations (F&E paper #128)'.
Chiarella, C., Dieci, R. & Gardini, L. 2003, 'A dynamic analysis of speculation across two markets (QFRC paper #89)'.
Chiarella, C., Flaschel, P., Franke, R. & Semmler, W. 2003, 'Output and the term structure of interest rates: Ways out of the jump-variable conundrum (F&E paper #125)'.
Chiarella, C., Flaschel, P. & Semmler, W. 2003, 'Real-financial interaction: implications of budget equations and capital accumulation (F&E paper #127)'.
Chiarella, C., Flaschel, P. & Zhu, P. 2003, 'The structure of Keynesian macrodynamics: a frame work for future research (F&E paper #129)'.
Chiarella, C., Flaschel, P., Groh, G., Koper, C. & Semmler, W. 2003, 'Toward applied disequilibrium growth theory: IV housing investment cycles, private debt accumulation and deflation (F&E paper #96)'.
Chiarella, C., Flaschel, P., Groh, G., Koper, C. & Semmler, W. 2003, 'Towards applied disequilibrium growth theory: V housing investment cycles, private debt accumulation and deflation (F&E paper #97)'.
Chiarella, C., He, X. & Zhu, P. 2003, 'Fading memory learning in the cobweb model with risk averse heterogeneous producers (QFRC paper #108)'.
Chiarella, C. & Gao, S. 2002, 'Solving the price earnings puzzle'.
Chiarella, C. & Gao, S. 2002, 'Type 1 spurious regression in economics'.
Chiarella, C., Flaschel, P., Franke, R. & Semmler, W. 2002, 'Stability analysis of a high-dimension macrodynamic model of real-financial interaction: a cascade of matrices approach'.
Chiarella, C. & He, X. 2002, 'An adaptive model on asset pricing and wealth dynamics with heterogeneous trading strategies', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 84 Abstract: This paper develops an adaptive model on asset pricing and wealth dynamic of a financial market with heterogeneous agents and examines the profitability of momentum and contrarian trading strategies. In order to characterize asset price, wealth dynamics and rational adaptiveness arising from the interaction of heterogeneous agents with CRRA utility, an adaptive discrete time equilibrium model in terms of return ad wealth proportions (among heterogeneous representative agents) is established. Taking trend followers and contrarians as the main hetergeneous agents in the model, the profitability of momentum and contrarian trading strategies is analyzed. Our results show the capability of the model to characterize some of the existing evidence on many of anomailies observed in financial markets, including the profitability of momentum trading strategies over short time intervals, rational adaptiveness of agents, overconfidence and underreaction, overreaction and herd behavior, excess volatility, and volatility clustering.
Chiarella, C. & Ziogas, A. 2002, 'Evaluation of American strangles', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 83 Abstract: This paper presents a generalisation of McKean's free boundary value problem for American options by considering an American strangle position, where the early exercise of one side of the payoff will knock-out the out-of-the-money side. When attempting to evaluate the price of this American strangle, it is not correct to simply price the component American call and put options which make up the strangle, and take the sum of their values. The Fourier transform technique is used to derive the integral equation for the price of our American strangle. From this expression, a coupled integral equation system for the strangle's call- and put-side free boundaries is found. While the equation for the price of the strangle is simply the sum of its component American call and put option equations, the free boundary for each side is shown to have a more complex nature. Anumerical algorithm for solving the coupled integral equation system for the free boundaries is provided, and the resulting approximations are used to determine the price of the American strangle position. Numerical comparisons between the strangle price and the price of a portfolio formed from a long position in both an American call an American put option are presented.
Bhar, R., Chiarella, C. & To, T. 2002, 'A maximum likelihood approach to estimation of Heath-Jarrow-Morton models', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 80 Abstract: Research on the Heath-Jarrow-Morton (1992) term structure models so far has focused on the class having time-deterministic instantaneous forward rate volatility. In this case the forward rate is Markovian, even if the spot rate process is not. However, this Markovian feature can only be used under the historical measure, involving two unsatisfactory assumptions: one on market price risk, usually made for pure mathematical tractability, the other to use futures yields as a proxy for the instantaneous forward rate, which may result in estimation bias. This paper circumvents both of these assumptions. First, the bias is quantified and shown to be non-negligible. Then futures contracts are treated as derivative instruments written on forward rates to derive the full information maximum likelihood estimator for observable futures prices, using both time series and cross-sectional data, without the need to assume and estimate any functional forms for the market price of interest rate risk. The derivation involves the likelihood transformation method of Duan (1994). The method is then applied to the estimation of a humped forward rate volatility model for Eurodollar futures series traded on the Chicago Mercantile Exchange.
Chiarella, C., Pasquali, S. & Runggaldier, W.J. 2001, 'On filtering in Markovian yerm structure models (An approximation approach)', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 65 Abstract: We study a nonlinear filtering problem to estimate, on the basis of noisy observations of forward rates, the market price of interest rate risk as well as the parameters in a particular term structure model within the Heath-Jarrow-Morton family. An approximation approach is described for the actual computation of the filter.
Bhar, R., Chiarella, C. & Runggaldier, W.J. 2001, 'Filtering equity risk premia from derivative prices', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 69 Abstract: This paper considers the measurement of the equity risk premium in financial markets. While there exists a vast amount of research into its behaviour, particularly in US markets, this is largely based on regression based techniques which do not capture well the dynamic and forward looking nature of the risk premium. In this paper the time variation of the unobserved risk premium is modelled by a system of stochastic differential equations connected by arbitrage arguments between the spot equity market, the index futures and options on index futures. Although various processes for the dynamics of the risk premium may be considered, we motivate and analyse a mean-reverting form. Since the risk premium is not directly observable, information on it is extracted using an unobserved component state space formulation of the system and Kalman filtering methodology. In order to cater for the time variation of volatility we use the option implied volatility in the dynamic equations for the index and its derivatives. This quantity is in a sense treated as a signal that impounds the market's forward looking view on the equity risk premium. The results using monthly Australian and U.S. market data over a period of five years are presented. The model fit is found to be statistically significant for both markets. The time series of the mean and standard deviation of the risk premia generated by the Kalman filter are compared with premia computed from ex-post returns. It is found that the ex-post risk premia have a general tendency to lie within a two standard deviations band around the filteredmean. However there are frequent movements outside the band, particularly on the downside, indicating that the ex-post measure may be understating the risk premium.
Bhar, R., Chiarella, C. & Runggaldier, W.J. 2001, 'Estimation in models of the instantaneous short term interest rate by use of a dynamic Bayesian algorithm', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 68 Abstract: This paper considers the estimation in models of the instantaneous short interest rate from a new perspective. Rather than using discretely compounded market rates as a proxy for the instantaneous short rate of interest, we set up the stochastic dynamics for the discretely compounded market observed rates and propose a dynamic Bayesian estimation algorithm (i.e. a filtering algorithm) for a time-discretised version of the resulting interest rate dynamics. The filter solution is computed via a further spatial discretization (quantization) and the convergence of the latter to its continuous counterpart is discussed in detail. The method is applied to simulated data and is found to give a reasonable estimate of the conditional density function and to be not too demanding computationally.
Chiarella, C. & He, X. 2001, 'Asset price and wealth dynamics under heterogeneous expectations', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 56 Abstract: In order to characterize asset price and wealth dynamics arising from the interaction of heterogeneous agents with CRRA utility, a discrete time stationary model in terms of return and wealth proportions (among different types of agents) is established. When fundamentalists and chartists are the main heterogeneous agents in the model, it is found that in the presence of heterogeneous agents the stationary model can have multiple steady-states. The steady-state is unstable when the chartists extrapolate strongly and (locally) stable when they extrapolate weakly. The convergence to steady-state follows an optimal selection principle - the return and wealth proportions tend to the steady-state which has relatively higher return. More importantly, heterogeneity can generate instability which, under the stochastic processes of the dividend yield and extrapolation rates, results in switching of the return among different states, such as steady-state, periodic and aperiodic cycles from time to time. To model that is finally developed displays the essential characteristics of the standard asset price dynamics model assumed in continuous time finance, in that the asset price is fluctuating around a geometrically growing trend. The model also displays the volatility clustering that is an essential feature of empirically observed assets returns.
Chiarella, C. & He, X. 2001, 'Dynamics of beliefs and learning under aL processes - The heterogeneous case', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 55 Abstract: This paper studies a class of models in which agents' expectations influence the actual dynamics while the expectations themselves are the outcome of some recursive processes with bounded memory. Under the assumptions of heterogeneous expectations (or beliefs) and that the agents update their expectations by recursive L- and general aL-processes, the dynamics of the resulting expectations and learning schemes are analyzed. It is shown that the dynamics of the system, including stability, instability and bifurcation, are affected differently by the recursive processes. The cobweb model with a simple heterogeneous expectation scheme is employed as an example to illustrate the stability results, the various types of bifurcations and the routes to complicated price dynamics. In particular, the double edged effect of heterogeneity on the dynamics of the model is demonstrated.
Chiarella, C. & He, X. 2001, 'Dynamics of beliefs and learning under aL processes - The homogeneous case', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 53 Abstract: This paper studies a class of models in which agents' expectations influence the actual dynamics while the expectations themselves are the outcome of some learning process. Under the assumptions that agents have homogeneous expectations (or beliefs) and that they update their expectations by least-squares L- and general aL - processes, the dynamic of the resulting expectations and learning schemes are analyzed. It is shown how the dynamics of the system, including stability, instability and bifurcation, are affected by the learning processes. The cobweb model with a simple homogeneous expectation scheme is employed as an example to illustrate the stability results, the various types of bifurcations and the routes to complicated price dynamics.
Chiarella, C. & Kwon, O. 2001, 'State variables and the affine nature of Markovian HJM term structure models', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 52 Abstract: Finite dimensional Markovian HJM term structure models provide an ideal setting for the study of term structure dynamics and interest rate derivatives where the flexibility of the HJM framework and the tractability of Markovian models coexist. Consequently, these models became the focus of a series of papers including Carverhill (1994), Ritchken and Sankarasuramanian (1995), Bhar and Chiarella (1997), Inui and Kijima (1998) and de Jong and Santa-Clara (1999). In Chiarella and Kwon (2001b), a common generalisation of these models was obtained in which the components of the forward rate volatility process satisfied ordinary differential equations in the maturity variable. However, the generalised models require the introduction of a large number of state variables which, at first sight, do not appear to have clear links to market observed quantities. In this paper, it is shown that the forward rate curves for these models can often be expressed as affine functions of the state variables, and conversely that the state variables in these models can often be expressed as affine functions of a finite number of benchmark forward rates. Consequently, for these models, the entire forward rate curve is not only Markov but affine with respect to a finite number of benchmark forward rates. It is also shown that the forward rate curve can be expressed as an affine function of a finite number of yields which are directly observed in the market. This property is useful, for example, in the estimation of model parameters. Finally, an explicit formula for the bond price in terms of the state variables, generalising the formula given in Inui and Kijima (1998), is provided for the models considered in this paper.
Chiarella, C., Dieci, R. & Gardini, L. 2001, 'Speculative behaviour and complex asset price dynamics', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 49 Abstract: This paper analyses the dynamics of a model of a share market consisting of two groups of traders: fundamentalists, who form rational expectations on the fundamental value of the asset, and chartists, who base their trading decisions on an analysis of past price trends. The model is reduced to a two-dimensional map whose dynamic behaviour is analysed in detail, particularly with respect to global dynamical behaviour. The dynamics are affected by parameters measuring the strength of fundamentalist demand and the speed with which chartists adjust their estimate of the trend to past price changes. The parameter space is characterized according to the local stability/instability of the equilibrium point as well as the noninvertibility of the map. The method of critical curves of noninvertible maps is used to understand and describe the range of global bifurcations that can occur. It is also shown how the knowledge of deterministic dynamics uncovered here can aid in understanding stochastic versions of the model.
Chiarella, C. & Kwon, O. 2000, 'A class of Heath-Jarrow-Morton term structure models with stochastic volatility', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 34 Abstract: A Class of Heath-Jarrow-Morton Term Structure Models with Stochastic Volatility Abstract: This paper considers a class of Heath-Jarrow-Morton term structure models with stochastic volatility. These models admit transformations to Markovian systems, and consequently lend themselves to well-established solution techniques for the bond and bond option prices. Solutions for certain special cases are obtained, and compared against their non-stochastic counterparts.
Bohm, V. & Chiarella, C. 2000, 'Mean variance preferences, expectations formation, and the dynamics of random asset prices', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 46 Abstract: This paper analyzes the dynamics of a general explicit random price process of finitely many assets in an economy with overlapping generations of heterogeneous consumers forming optimal portfolios, extending the one dimensional investigation of Bohm, Deutscher and Wenzelburger (2000). Consumers maximize expected utility with respect to subjective transition probabilities defined by Markov kernels. Given a forecasting rule (predictor) and an exogeneous stochastic process of producer dividends, the dynamics of the economy is described as a random dynamical system in the sense of Arnold (1998). The paper investigates existence and stability of random fixed points (invariant measures) for mean-variance preferences under various forecasting schemes, including unbiased predictions as well as OLS forecasting. Numerical simulations show the stability and the performance of the different predictors for linear mean-variance preferences. Alternative random dividend processes are provided.
Chiarella, C. & Kwon, O. 2000, 'A complete stochastic volatility model in the HJM framework', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 43 Abstract: This paper considers a stochastic volatility version of the Heath, Jarrow and Morton (1992) term structure model. Market completeness is obtained by adapting the Hobson and Rogers (1998) complete stochastic volatility stock market model to the interest rate setting. Numerical simulation for a special case is used to compare the stochastic volatility model against the traditional Vasicek (1977) model.
Bhar, R. & Chiarella, C. 2000, 'Infering forward looking financial market risk premia from derivatives prices', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 42 Abstract: This paper focuses on a topical and important area of theory and practice ie. The risk premium in financial markets. While there exists a vast amount of research into its behaviour, particularly in US markets, this is largely based on regression based techniques which do not capture well the dynamic and forward looking nature of the risk premium. In this paper the variation of the unobserved risk premium is modelled by a system of stochastic differential equations connected by arbitrage arguments between the spot equity market, the index futures and options on index futures. Although various processes for the dynamic of the risk premium may be considered, we motivate and analyse a mean-reverting form. The diffusion part is specified such that the risk premium remains positive. Since the risk premium is not directly observable, information on it is extracted using an unobserved component state space formulation of the system and filtering methodology. As an initial application of the methodology, the results from daily Australian market data from the SFE over a period of twelve months are presented. The small sample properties of the parameter estimates are also examined by bootstrapping the state space system. It is well known in the filtering literature that the estimation of state space system by Kalman filter is sensitive to the specification of the quantities such as initial state variables and the prior covariance matrix. The paper also carries out approximate sensitivity analysis in this respect.
Bhar, R., Chiarella, C. & Pham, T.M. 2000, 'Modeling the currency forward risk premium: Theory and evidence', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 41 Abstract: There is a huge literature on the existence of risk premia in the foreign exchange markets and its influence in explaining the divergence between the forward exchange rate and the subsequently realised spot exchange rate. In this paper, we seek to model directly the risk premium as a mean-reverting diffusion process. This is done by making use of the spot-forward price relationship and assuming a geometric Brownian process for the spot exchange rate. We are able to obtain a stochastic differential equation system for the spot exchange rate, the forward exchange rate and the risk premium which we estimate using Kalman filtering techniques. The model is then applied to the French Franc/USD and Japanese Yen/USD exchange rates from 1 January 1990 to 31 December 1998. For both currencies our main findings show (I) the persistence of substantial positive time variation in the forward risk premium and its alternating regimes; and (ii) the presence of a term structure of the forward risk premia.
Chiarella, C., Craddock, M.J. & El-Hassan, N. 2000, 'The calibration of stock option pricing models using inverse problem methodology', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 39 Abstract: We analyse the procedure for determining volatility presented by Lagnado and Osher, and explain in some detail where the scheme comes from. We present an alternative scheme which avoids some of the technical complications arising in Lagnado and Osher's approach. An algorithm for solving the resulting equations is given, along with a selection of numerical examples.
Chiarella, C. & He, X. 2000, 'Stability of competitive equilibria with heterogeneous beliefs and learning', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 37 Abstract: The paper studies a class of models in which agents' expectations influence the actual dynamics while the expectations themselves are the outcome of some learning processes. Situations of both homogeneous and heterogeneous beliefs are considered. In both cases agents update their expectations by general ah - and least-squares h-processes and the stability of the resulting dynamics in both cases is analysed. It is shown how the stability of the actual dynamics is affected by the heterogeneous expectations and different least-squares h-processes.
Bhar, R., Chiarella, C., El-Hassan, N. & Zheng, X. 2000, 'The reduction of forward rate dependent volatility HJM models to Markovian form: Pricing European bond option', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 36 Abstract: We consider a single factor Heath-Jarrow-Morton model with a forward rate volatility function depending upon a function of time to maturity, the instantaneous spot rate of interest and a forward rate to a fixed maturity. With this specification the stochastic dynamics determining the prices of interest rate derivatives may be reduced to Markovian form. Furthermore, the evolution of the forward rate curve is completely determined by the two rates specified in the volatility function and it is thus possible to obtain a closed form expression for bond prices. The prices of bond options are determined by a partial differential equation involving two spatial variables. We discuss the evaluation of European bond options in this framework by use of the ADI method.
Chiarella, C. & He, X. 2000, 'Heterogeneous beliefs, risk and learning in a simple asset pricing model with a market maker', Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney.
Research Paper Number: 35