Advanced Search
MyIDEAS: Login to save this article or follow this journal

Properties of equilibrium asset prices under alternative learning schemes

Contents:

Author Info

  • Guidolin, Massimo
  • Timmermann, Allan

Abstract

This paper characterizes equilibrium asset prices under adaptive, rational and Bayesian learning schemes in a model where dividends evolve on a binomial lattice. The properties of equilibrium stock and bond prices under learning are shown to differ significantly compared with prices under full information rational expectations. Learning causes the discount factor and risk-neutral probability measure to become path-dependent and introduces serial correlation and volatility clustering in stock returns. We also derive conditions under which the expected value and volatility of stock prices will be higher under learning than under full information. Finally, we derive restrictions on prior beliefs under which Bayesian and rational learning lead to identical prices and show how the results can be generalized to more complex settings where dividends follow either multi-state i.i.d. distributions or multi-state Markov chains.

(This abstract was borrowed from another version of this item.)

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.sciencedirect.com/science/article/B6V85-4JHMFC4-2/2/d0e28ff1a4f97d3e11cc727c34e383c2
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 31 (2007)
Issue (Month): 1 (January)
Pages: 161-217

as in new window
Handle: RePEc:eee:dyncon:v:31:y:2007:i:1:p:161-217

Contact details of provider:
Web page: http://www.elsevier.com/locate/jedc

Related research

Keywords:

Other versions of this item:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Campbell, John Y & Shiller, Robert J, 1988. " Stock Prices, Earnings, and Expected Dividends," Journal of Finance, American Finance Association, vol. 43(3), pages 661-76, July.
  2. Montrucchio, Luigi & Privileggi, Fabio, 1999. "On Fragility of Bubbles in Equilibrium Asset Pricing Models of Lucas-Type," POLIS Working Papers, Institute of Public Policy and Public Choice - POLIS 5, Institute of Public Policy and Public Choice - POLIS.
  3. Blume, L. E. & Bray, M. M. & Easley, D., 1982. "Introduction to the stability of rational expectations equilibrium," Journal of Economic Theory, Elsevier, vol. 26(2), pages 313-317, April.
  4. Wieland, Volker, 2000. "Learning by doing and the value of optimal experimentation," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 24(4), pages 501-534, April.
  5. Kurz, Mordecai, 1994. "On the Structure and Diversity of Rational Beliefs," Economic Theory, Springer, vol. 4(6), pages 877-900, October.
  6. Chen, Xiaohong & White, Halbert, 1998. "Nonparametric Adaptive Learning with Feedback," Journal of Economic Theory, Elsevier, vol. 82(1), pages 190-222, September.
  7. Jonathan Lewellen & Jay Shanken, 2002. "Learning, Asset-Pricing Tests, and Market Efficiency," Journal of Finance, American Finance Association, vol. 57(3), pages 1113-1145, 06.
  8. Andrew B. Abel, 2001. "An Exploration of the Effects of Pessimism and Doubt on Asset Returns," NBER Working Papers 8132, National Bureau of Economic Research, Inc.
  9. Prescott, Edward C & Mehra, Rajnish, 1980. "Recursive Competitive Equilibrium: The Case of Homogeneous Households," Econometrica, Econometric Society, Econometric Society, vol. 48(6), pages 1365-79, September.
  10. Tim W. Cogley & Thomas J. Sargent, 2005. "Anticipated Utility and Rational Expectations as Approximations of Bayesian Decision Making," Working Papers 523, University of California, Davis, Department of Economics.
  11. James Bullard & John Duffy, 1998. "Learning and excess volatility," Working Papers 1998-016, Federal Reserve Bank of St. Louis.
  12. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(2), pages 249-65, April.
  13. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, Econometric Society, vol. 50(5), pages 1269-86, September.
  14. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, Elsevier, vol. 7(3), pages 229-263, September.
  15. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  16. Brandt, M.W.Michael W. & Zeng, Qi & Zhang, Lu, 2004. "Equilibrium stock return dynamics under alternative rules of learning about hidden states," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 28(10), pages 1925-1954, September.
  17. Robert J. Shiller, 1980. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," NBER Working Papers 0456, National Bureau of Economic Research, Inc.
  18. Timmermann, Allan, 1996. "Excess Volatility and Predictability of Stock Prices in Autoregressive Dividend Models with Learning," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 63(4), pages 523-57, October.
  19. Bray, Margaret, 1982. "Learning, estimation, and the stability of rational expectations," Journal of Economic Theory, Elsevier, vol. 26(2), pages 318-339, April.
  20. Ferson, Wayne E. & Constantinides, George M., 1991. "Habit persistence and durability in aggregate consumption: Empirical tests," Journal of Financial Economics, Elsevier, Elsevier, vol. 29(2), pages 199-240, October.
  21. Volker Wieland, 1999. "Monetary policy, parameter uncertainty and optimal learning," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1999-48, Board of Governors of the Federal Reserve System (U.S.).
  22. Rubinstein, Mark, 1974. "An aggregation theorem for securities markets," Journal of Financial Economics, Elsevier, Elsevier, vol. 1(3), pages 225-244, September.
  23. Frydman, Roman, 1982. "Towards an Understanding of Market Processes: Individual Expectations, Learning, and Convergence to Rational Expectations Equilibrium," American Economic Review, American Economic Association, vol. 72(4), pages 652-68, September.
  24. Robert B. Barsky & J. Bradford De Long, 1992. "Why Does the Stock Market Fluctuate?," NBER Working Papers 3995, National Bureau of Economic Research, Inc.
  25. Andrew W. Lo, A. Craig MacKinlay, 1988. "Stock Market Prices do not Follow Random Walks: Evidence from a Simple Specification Test," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 41-66.
  26. Blume, Lawrence E. & Easley, David, 1984. "Rational expectations equilibrium: An alternative approach," Journal of Economic Theory, Elsevier, vol. 34(1), pages 116-129, October.
  27. Abel, Andrew B., 1988. "Stock prices under time-varying dividend risk : An exact solution in an infinite-horizon general equilibrium model," Journal of Monetary Economics, Elsevier, Elsevier, vol. 22(3), pages 375-393.
  28. Andrea Buraschi & Alexei Jiltsov, 2006. "Model Uncertainty and Option Markets with Heterogeneous Beliefs," Journal of Finance, American Finance Association, vol. 61(6), pages 2841-2897, December.
  29. Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, Elsevier, vol. 52(1-2), pages 5-59.
  30. Allan Timmermann & Massimo Guidolin, 2001. "Option Prices under Bayesian Learning: Implied Volatility Dynamics and Predictive Densities," FMG Discussion Papers, Financial Markets Group dp397, Financial Markets Group.
  31. Timmermann, Allan, 2001. "Structural Breaks, Incomplete Information and Stock Prices," University of California at San Diego, Economics Working Paper Series qt1sn269d7, Department of Economics, UC San Diego.
  32. Barucci, Emilio, 2000. "Exponentially fading memory learning in forward-looking economic models," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 24(5-7), pages 1027-1046, June.
  33. Veronesi, Pietro, 1999. "Stock Market Overreaction to Bad News in Good Times: A Rational Expectations Equilibrium Model," Review of Financial Studies, Society for Financial Studies, vol. 12(5), pages 975-1007.
  34. Grossman, Sanford J & Shiller, Robert J, 1981. "The Determinants of the Variability of Stock Market Prices," American Economic Review, American Economic Association, vol. 71(2), pages 222-27, May.
  35. Massimo Guidolin, 2006. "High equity premia and crash fears - Rational foundations," Economic Theory, Springer, vol. 28(3), pages 693-708, 08.
  36. Beck, Gunter W. & Wieland, Volker, 2002. "Learning and control in a changing economic environment," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 26(9-10), pages 1359-1377, August.
  37. Stapleton, Richard C & Subrahmanyam, Marti G, 1984. " The Valuation of Options When Asset Returns Are Generated by a Binomial Process," Journal of Finance, American Finance Association, vol. 39(5), pages 1525-39, December.
  38. Mordecai Kurz & Maurizio Motolese, . "Endogenous Uncertainty and Market Volatility," Working Papers, Stanford University, Department of Economics 99005, Stanford University, Department of Economics.
  39. LeRoy, Stephen F & Porter, Richard D, 1981. "The Present-Value Relation: Tests Based on Implied Variance Bounds," Econometrica, Econometric Society, Econometric Society, vol. 49(3), pages 555-74, May.
  40. Mordecai Kurz & Hehui Jin & Maurizio Motolese, 2005. "Determinants of stock market volatility and risk premia," Annals of Finance, Springer, vol. 1(2), pages 109-147, 07.
  41. Constantinides, George M, 1982. "Intertemporal Asset Pricing with Heterogeneous Consumers and without Demand Aggregation," The Journal of Business, University of Chicago Press, vol. 55(2), pages 253-67, April.
  42. Lakner, Peter, 1995. "Utility maximization with partial information," Stochastic Processes and their Applications, Elsevier, Elsevier, vol. 56(2), pages 247-273, April.
  43. Rajnish Mehra, 2006. "Recursive Competitive Equilibrium," NBER Working Papers 12433, National Bureau of Economic Research, Inc.
  44. Detemple, Jerome B, 1986. " Asset Pricing in a Production Economy with Incomplete Information," Journal of Finance, American Finance Association, vol. 41(2), pages 383-91, June.
  45. Brennan, Michael J. & Xia, Yihong, 2001. "Stock price volatility and equity premium," Journal of Monetary Economics, Elsevier, Elsevier, vol. 47(2), pages 249-283, April.
  46. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  47. Kuan, Chung-Ming & White, Halbert, 1994. "Adaptive Learning with Nonlinear Dynamics Driven by Dependent Processes," Econometrica, Econometric Society, Econometric Society, vol. 62(5), pages 1087-1114, September.
  48. Townsend, Robert M, 1978. "Market Anticipations, Rational Expectations, and Bayesian Analysis," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 19(2), pages 481-94, June.
  49. Evans, George W & Honkapohja, Seppo, 1995. "Local Convergence of Recursive Learning to Steady States and Cycles in Stochastic Nonlinear Models," Econometrica, Econometric Society, Econometric Society, vol. 63(1), pages 195-206, January.
  50. repec:cup:macdyn:v:5:y:2001:i:2:p:272-302 is not listed on IDEAS
  51. Timmermann, Allan G, 1993. "How Learning in Financial Markets Generates Excess Volatility and Predictability in Stock Prices," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 108(4), pages 1135-45, November.
  52. Veronesi, Pietro, 2004. "The Peso problem hypothesis and stock market returns," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 28(4), pages 707-725, January.
  53. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, Econometric Society, vol. 46(6), pages 1429-45, November.
  54. Gennotte, Gerard, 1986. " Optimal Portfolio Choice under Incomplete Information," Journal of Finance, American Finance Association, vol. 41(3), pages 733-46, July.
  55. Bray, Margaret M & Savin, Nathan E, 1986. "Rational Expectations Equilibria, Learning, and Model Specification," Econometrica, Econometric Society, Econometric Society, vol. 54(5), pages 1129-60, September.
  56. Blume, Lawrence E. & Easley, David, 1982. "Learning to be rational," Journal of Economic Theory, Elsevier, vol. 26(2), pages 340-351, April.
  57. Chamberlain, Gary, 1987. "Asymptotic efficiency in estimation with conditional moment restrictions," Journal of Econometrics, Elsevier, Elsevier, vol. 34(3), pages 305-334, March.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Subrahmanyam, Avanidhar, 2009. "Optimal financial education," Review of Financial Economics, Elsevier, Elsevier, vol. 18(1), pages 1-9, January.
  2. Massimo Guidolin, 2006. "High equity premia and crash fears - Rational foundations," Economic Theory, Springer, vol. 28(3), pages 693-708, 08.
  3. Subrahmanyam, Avanidhar, 2008. "Learning from experience and trading volume," Review of Financial Economics, Elsevier, Elsevier, vol. 17(4), pages 245-260, December.
  4. Cars Hommes & Mei Zhu, 2013. "Behavioral Learning Equilibria," Tinbergen Institute Discussion Papers 13-014/II, Tinbergen Institute.
  5. Bullard, J.B. & Suda, J., 2011. "The Stability of Macroeconomic Systems with Bayesian Learners," Working papers, Banque de France 332, Banque de France.
  6. Volker Wieland & Christos Koulovatianos, 2011. "Asset Pricing under Rational Learning about Rare Disasters," 2011 Meeting Papers 1417, Society for Economic Dynamics.
  7. Fabio Milani, 2008. "Learning about the Interdependence between the Macroeconomy and the Stock Market," Working Papers 070819, University of California-Irvine, Department of Economics.
  8. Hommes, Cars & Zhu, Mei, 2014. "Behavioral learning equilibria," Journal of Economic Theory, Elsevier, vol. 150(C), pages 778-814.
  9. Christos Koulovatianos, . "A Paradox of Environmental Awareness Campaigns," Discussion Papers 10/17, University of Nottingham, School of Economics.
  10. Massimo Guidolin, 2005. "Pessimistic beliefs under rational learning: quantitative implications for the equity premium puzzle," Working Papers 2005-005, Federal Reserve Bank of St. Louis.
  11. Timmermann, Allan, 2008. "Elusive return predictability," International Journal of Forecasting, Elsevier, Elsevier, vol. 24(1), pages 1-18.
  12. Christos Koulovatianos, 2014. "Strategic Exploitation of a Common-Property Resource Under Rational Learning About its Reproduction," CREA Discussion Paper Series 14-06, Center for Research in Economic Analysis, University of Luxembourg.
  13. Consiglio, Andrea & Russino, Annalisa, 2007. "How does learning affect market liquidity? A simulation analysis of a double-auction financial market with portfolio traders," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 31(6), pages 1910-1937, June.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:eee:dyncon:v:31:y:2007:i:1:p:161-217. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.