Can market volumes reveal traders’ rationality and a new risk premium?

ArXiv ID: 2406.05854 “View on arXiv”

Authors: Unknown

Abstract

An empirical analysis, suggested by optimal Merton dynamics, reveals some unexpected features of asset volumes. These features are connected to traders’ belief and risk aversion. This paper proposes a trading strategy model in the optimal Merton framework that is representative of the collective behavior of heterogeneous rational traders. This model allows for the estimation of the average risk aversion of traders acting on a specific risky asset, while revealing the existence of a price of risk closely related to market price of risk and volume rate. The empirical analysis, conducted on real data, confirms the validity of the proposed model.

Keywords: Merton Dynamics, Risk Aversion, Market Price of Risk, Heterogeneous Traders, Optimal Control, Equities / Risky Assets

Complexity vs Empirical Score

• Math Complexity: 7.0/10
• Empirical Rigor: 6.0/10
• Quadrant: Holy Grail
• Why: The paper employs advanced stochastic control and stochastic calculus (Merton problem, optimal portfolios, diffusion processes) which indicates high mathematical density. It also presents a robust empirical analysis on real NYSE data for specific stocks (PFE, VZ, Coca-Cola), estimating parameters like risk aversion and validating the model with time-series analysis.

  flowchart TD
    A["Research Goal:<br>Can market volumes reveal<br>traders' rationality & risk premium?"]
    
    B["Methodology:<br>Optimal Merton Dynamics<br>Optimal Control Framework"]
    
    C["Data Input:<br>Real Market Data<br>Risky Assets/Equities"]
    
    D["Computation:<br>Estimate Average Risk Aversion<br>of Heterogeneous Traders"]
    
    E["Outcome 1:<br>Existence of Price of Risk<br>linked to Volume Rate"]
    
    F["Outcome 2:<br>Empirical Validation<br>of Trading Strategy Model"]
    
    A --> B
    B --> C
    C --> D
    D --> E
    D --> F