Endogenous cycles in heterogeneous agent models: a state-space approach

This paper proposes an empirical test to identify possible endogenous cycles withinheterogeneous agent models (HAMs). We consider a two-type HAM into a standardsmall-scale dynamic asset pricing framework. Fundamentalists base their expectationson the fundamental value, while chartists consider the level of past prices. Becausethese strategies, by their nature, cannot be directly observed but can cause the responseof the observed data, we construct a state-space model where agents’ beliefs areconsidered the unobserved state components and from which the heterogeneity offundamentalist-chartist trader cycles can be mathematically derived and empiricallytested. The model is estimated using the S&P500 index for the period 1990–2020 at different time scales, specifically, quarterly, monthly, and daily. We find empiricalevidence of endogenous damped fluctuations with a higher probability of chartistbehavior in the short-term horizon. In addition, the model exhibits better long-runout-of-sample forecasting accuracy compared to the benchmark random walk model.