Impact of strategy switching on wealth accumulation

Abstract

Various investment strategies coexist in financial markets. Fluctuations in the profitability of strategies rationalize investors’ strategy switching behaviors. Under bounded rationality and limited information, such behavior is usually driven by comparing the past performance of different strategies. But at what pace should investors change their strategies? Does a frequent strategy switching lead to a higher wealth in the end? To answer these questions, a discrete dynamic heterogeneous agent model is proposed, in which agents follow heuristic rules and a market maker adjusts the price of a risky asset. Agents are classified by their propensity of strategy switching. It is found that agents with a higher propensity adopt the better strategy more often, but end up with less final wealth. This counter-intuitive phenomenon is caused by the inconsistency between short-run profit and long-run wealth accumulation.