Endogenous regime switching in speculative markets

Abstract

This paper examines a nonlinear disequilibrium model of price formation in speculative markets with two groups of speculators, fundamentalists and chartists. The behavior of the fundamentalists is stabilizing, whereas that of the chartists is destabilizing; a sufficiently high share of wealth in the hands of the latter group can cause attracting periodic orbits to arise. If information about fundamentals is costly to obtain, then chartists obtain higher pay-offs in a stable regime, while fundamentalists perform better in an unstable regime. This gives rise to endogenous regime switching: the market alternates between periods of stability and instability, with the transition from one regime to another determined endogenously through the evolution of wealth shares.

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