Behavioural heterogeneity in the New Zealand stock market

ABSTRACT

We examine the dynamics of the New Zealand stock market using an asset pricing model with heterogeneous agents. Applying the model to historical data from 1899 to 2015, we identify both fundamentalist and trend-following (chartist) behaviours of investors. In addition, we document that investors switch between fundamentalist and chartist rules when either of these rules has been more profitable in the recent past. Both behaviours contribute to large fluctuations of stock prices relative to their fundamental value and can explain some of the dynamics around bubbles and crashes.

KEYWORDS:

• Asset pricing
• heterogeneous agents model
• behavioural finance
• New Zealand

JEL CLASSIFICATION:

• G12
• C22

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. A related but different strand of research was instigated by De Long, Shleifer, Summers, and Waldman (1990, 1991), who also distinguish between fundamental traders and chartists (which they refer to as noise traders). De Long et al. (1990, 1991) distinguish between two groups of traders: sophisticated traders and noise traders. Sophisticated traders have rational expectations, whereas, noise traders trade on noise and have biased beliefs about the value of the stock (i.e. they could be optimistic and overvalue the asset relative to its rational value). Both types of traders are present in the market in fixed proportions, and sophisticated traders face a risk when trading on their beliefs that is induced by the noise traders.

2. One of the well-known example of trend-followers’ decision-making is the ‘moving average’ trading rule. This rule states that investors should buy assets when a 1 week moving average (short-term) is above a 12 week or longer moving average (long-term) from below and vice versa (Hommes, 2006).

3. We thank the referee for pointing these simulations out to us.

4. We generate a normally distributed series with a constant mean and variance from time t − 8 to t − 1, followed by a positive (bubble) or negative (crash) shock at time t.