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Bounded rationality, adaptive behaviour, and asset prices

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  • Zhao, Dongxu
  • Li, Kai

Abstract

This paper develops a simple heterogeneous agent model (HAM) of asset prices with bounded rationality and adaptive behaviour. The model features feedback loop that amplifies shocks and leads to large price fluctuations. Our model not only retains the nonlinear interaction between prices and population in HAMs but also allows for a quantitative comparison with the data. Estimating the model to the data shows that the feedback loop helps explain the large variations in expected returns, such as return predictability and excess volatility.

Suggested Citation

  • Zhao, Dongxu & Li, Kai, 2022. "Bounded rationality, adaptive behaviour, and asset prices," International Review of Financial Analysis, Elsevier, vol. 80(C).
    • Handle: RePEc:eee:finana:v:80:y:2022:i:c:s1057521922000163
    DOI: 10.1016/j.irfa.2022.102037
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    More about this item

    Keywords

    Bounded rationality; Adaptive behaviour; Feedback; Regime switching; Estimation; Heterogeneity;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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