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Properties of equilibrium asset prices under alternative learning schemes

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  • 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.

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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

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Handle: RePEc:eee:dyncon:v:31:y:2007:i:1:p:161-217

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Web page: http://www.elsevier.com/locate/jedc

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Citations

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Cited by:
  1. Cars Hommes & Mei Zhu, 2013. "Behavioral Learning Equilibria," Tinbergen Institute Discussion Papers 13-014/II, Tinbergen Institute.
  2. Volker Wieland & Christos Koulovatianos, 2011. "Asset Pricing under Rational Learning about Rare Disasters," 2011 Meeting Papers 1417, Society for Economic Dynamics.
  3. Christos Koulovatianos, . "A Paradox of Environmental Awareness Campaigns," Discussion Papers 10/17, University of Nottingham, School of Economics.
  4. Cars Hommes & Mei Zhu, 2013. "Behavioral Learning Equilibria," Tinbergen Institute Discussion Papers 13-014/II, Tinbergen Institute.
  5. 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.
  6. Hommes, C.H. & Zhu, M., 2012. "Behavioral Learning Equilibria," CeNDEF Working Papers 12-09, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  7. Bullard, J.B. & Suda, J., 2011. "The Stability of Macroeconomic Systems with Bayesian Learners," Working papers 332, Banque de France.
  8. Subrahmanyam, Avanidhar, 2008. "Learning from experience and trading volume," Review of Financial Economics, Elsevier, vol. 17(4), pages 245-260, December.
  9. Fabio Milani, 2008. "Learning about the Interdependence between the Macroeconomy and the Stock Market," Working Papers 070819, University of California-Irvine, Department of Economics.
  10. Subrahmanyam, Avanidhar, 2009. "Optimal financial education," Review of Financial Economics, Elsevier, vol. 18(1), pages 1-9, January.
  11. Massimo Guidolin, 2006. "High equity premia and crash fears - Rational foundations," Economic Theory, Springer, vol. 28(3), pages 693-708, 08.
  12. Timmermann, Allan, 2008. "Elusive return predictability," International Journal of Forecasting, Elsevier, vol. 24(1), pages 1-18.
  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, vol. 31(6), pages 1910-1937, June.

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