Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/84867
Authors: 
Fischer, Thomas
Year of Publication: 
2012
Series/Report no.: 
Darmstadt Discussion Papers in Economics 212
Abstract: 
In this paper, a model of bounded rational investors investing their portfolio in a passive investment vehicle (e.g., an Exchange Traded Fund replicating a broad index) or an actively managed fund is presented. The model proposes that the quick reswitching of these short-term oriented investors induces momentum behavior in prices. Investors prefer passsive funds in time of low risk-free rates and when active funds charge high management costs. Actively managed funds have a lower volatility but are only able to outperform the passive funds in downturns. Simulations confirm the emergence of two regimes: a regime where prices are close to fundamentals and another regime with a positive bubble. The size and the length of this bubble increases for low market liquidity and high switching speed of investors. The market volatility increases for strong reswitching activities and short-term thinking of bounded rational investors. Negative bubbles (market prices lower than fundamentals) tend to occur if active portfolio managers exhibit high risk aversion, but are less frequent than positive bubbles.
Subjects: 
stock
market
passive
trading
financial
stability
arbitrage
trading
financial
bubbles
Heterogeneous
Agent
Model
JEL: 
G11
C15
C62
D58
Document Type: 
Working Paper

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