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Learning And Excess Volatility

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  • Bullard, James
  • Duffy, John

Abstract

We introduce adaptive learning behavior into a general-equilibrium life-cycle economy with capital accumulation. Agents form forecasts of the rate of return to capital assets using least-squares autoregressions on past data. We show that, in contrast to the perfect-foresight dynamics, the dynamical system under learning possesses equilibria that are characterized by persistent excess volatility in returns to capital. We explore a quantitative case for theselearning equilibria. We use an evolutionary search algorithm to calibrate a version of the system under learning and show that this system can generate data that matches some features of the time-series data for U.S. stock returns and per-capita consumption. We argue that this finding provides support for the hypothesis that the observed excess volatility of asset returns can be explained by changes in investor expectations against a background of relatively small changes in fundamental factors.

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Bibliographic Info

Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 5 (2001)
Issue (Month): 02 (April)
Pages: 272-302

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Handle: RePEc:cup:macdyn:v:5:y:2001:i:02:p:272-302_01

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  6. Timmermann, Allan, 1996. "Excess Volatility and Predictability of Stock Prices in Autoregressive Dividend Models with Learning," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 523-57, October.
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  8. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-79, March.
  9. Campbell, John Y., 1999. "Asset prices, consumption, and the business cycle," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 19, pages 1231-1303 Elsevier.
  10. Brock, W.A. & Hommes, C.H., 1996. "A Rational Route to Randomness," Working papers 9530r, Wisconsin Madison - Social Systems.
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  13. James Bullard, 1991. "Learning equilibria," Working Papers 1991-004, Federal Reserve Bank of St. Louis.
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  15. James M. Poterba & Lawrence H. Summers, 1987. "Mean Reversion in Stock Prices: Evidence and Implications," NBER Working Papers 2343, National Bureau of Economic Research, Inc.
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  17. Arifovic, Jasmina & Bullard, James & Duffy, John, 1997. " The Transition from Stagnation to Growth: An Adaptive Learning Approach," Journal of Economic Growth, Springer, vol. 2(2), pages 185-209, July.
  18. LeRoy, Stephen F & Porter, Richard D, 1981. "The Present-Value Relation: Tests Based on Implied Variance Bounds," Econometrica, Econometric Society, vol. 49(3), pages 555-74, May.
  19. W. Brian Arthur & John H. Holland & Blake LeBaron & Richard Palmer & Paul Taylor, 1996. "Asset Pricing Under Endogenous Expectation in an Artificial Stock Market," Working Papers 96-12-093, Santa Fe Institute.
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