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This paper is a contribution to the literature on the explanatory power and calibration of heterogeneous asset pricing models. We set out a new stochastic market-fraction asset pricing model of fundamentalists and trend followers under a market maker. Our model explains key features of financial market behaviour such as market dominance, convergence to the fundamental price and under- and over-reaction. We use the dynamics of the underlying deterministic system to characterize these features and statistical properties, including convergence of the limiting distribution and autocorrelation structure. We confirm these properties using Monte Carlo simulations. [ABSTRACT FROM AUTHOR]

Abstract: 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. [Copyright &y& Elsevier]