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Advances in Decision Sciences
Volume 2015 (2015), Article ID 971269, 18 pages
Research Article

Loss Aversion, Adaptive Beliefs, and Asset Pricing Dynamics

Department of Social Science Computing, Faculty of Economics and Political Science, Cairo University, Cairo 11431, Egypt

Received 17 March 2015; Revised 30 June 2015; Accepted 10 September 2015

Academic Editor: Wing K. Wong

Copyright © 2015 Kamal Samy Selim et al. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.


We study asset pricing dynamics in artificial financial markets model. The financial market is populated with agents following two heterogeneous trading beliefs, the technical and the fundamental prediction rules. Agents switch between trading rules with respect to their past performance. The agents are loss averse over asset price fluctuations. Loss aversion behaviour depends on the past performance of the trading strategies in terms of an evolutionary fitness measure. We propose a novel application of the prospect theory to agent-based modelling, and by simulation, the effect of evolutionary fitness measure on adaptive belief system is investigated. For comparison, we study pricing dynamics of a financial market populated with chartists perceive losses and gains symmetrically. One of our contributions is validating the agent-based models using real financial data of the Egyptian Stock Exchange. We find that our framework can explain important stylized facts in financial time series, such as random walk price behaviour, bubbles and crashes, fat-tailed return distributions, power-law tails in the distribution of returns, excess volatility, volatility clustering, the absence of autocorrelation in raw returns, and the power-law autocorrelations in absolute returns. In addition to this, we find that loss aversion improves market quality and market stability.