Advanced Search
MyIDEAS: Login

Internal rationality, imperfect market knowledge and asset prices

Contents:

Author Info

  • Adam, Klaus
  • Marcet, Albert

Abstract

We present a decision theoretic framework in which agents are learning about market behavior and that provides microfoundations for models of adaptive learning. Agents are 'internally rational', i.e., maximize discounted expected utility under uncertainty given dynamically consistent subjective beliefs about the future, but agents may not be 'externally rational', i.e., may not know the true stochastic process for payoff relevant variables beyond their control. This includes future market outcomes and fundamentals. We apply this approach to a simple asset pricing model and show that the equilibrium stock price is then determined by investors[modifier letter apostrophe] expectations of the price and dividend in the next period, rather than by expectations of the discounted sum of dividends. As a result, learning about price behavior affects market outcomes, while learning about the discounted sum of dividends is irrelevant for equilibrium prices. Stock prices equal the discounted sum of dividends only after making very strong assumptions about agents[modifier letter apostrophe] market knowledge.

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/pii/S0022053110001638
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 Theory.

Volume (Year): 146 (2011)
Issue (Month): 3 (May)
Pages: 1224-1252

as in new window
Handle: RePEc:eee:jetheo:v:146:y:2011:i:3:p:1224-1252

Contact details of provider:
Web page: http://www.elsevier.com/locate/inca/622869

Related research

Keywords: Learning Internal rationality Consumption based asset pricing;

Other versions of this item:

Find related papers by JEL classification:

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. George W. Evans & Seppo Honkapohja, 2003. "Adaptive learning and monetary policy design," Proceedings, Federal Reserve Bank of Cleveland, pages 1045-1084.
  2. Manuel S. Santos & Michael Woodford, 1993. "Rational Asset Pricing Bubbles," Working Papers 9304, Centro de Investigacion Economica, ITAM.
  3. Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," Working Paper 2003-18, Federal Reserve Bank of Atlanta.
  4. Timmermann, Allan G, 1993. "How Learning in Financial Markets Generates Excess Volatility and Predictability in Stock Prices," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1135-45, November.
  5. Chakraborty, Avik & Evans, George W., 2008. "Can perpetual learning explain the forward-premium puzzle?," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 477-490, April.
  6. George W. Evans & Seppo Honkapohja, 2003. "Policy Interaction, Expectations and the Liquidity Trap," University of Oregon Economics Department Working Papers 2003-33, University of Oregon Economics Department, revised 06 Jul 2004.
  7. Adam, Klaus, 2003. "Learning to Forecast and Cyclical Behavior of Output and Inflation," CFS Working Paper Series 2003/01, Center for Financial Studies (CFS).
  8. Orphanides, Athanasios & Williams, John C., 2003. "Imperfect knowledge, inflation expectations, and monetary policy," CFS Working Paper Series 2003/40, Center for Financial Studies (CFS).
  9. Pesaran, M.H. & Pettenuzzo, D. & Timmermann, A., 2006. "Learning, Structural Instability and Present Value Calculations," Cambridge Working Papers in Economics 0602, Faculty of Economics, University of Cambridge.
  10. Albert Marcet & Juan P. Nicolini, 1995. "Recurrent hyperinflations and learning," Economics Working Papers 244, Department of Economics and Business, Universitat Pompeu Fabra, revised Nov 2001.
  11. Fudenberg, D. & Levine, D.K., 1991. "Self-Confirming Equilibrium ," Working papers 581, Massachusetts Institute of Technology (MIT), Department of Economics.
  12. Stefano Eusepi & Bruce Preston, 2011. "Expectations, Learning, and Business Cycle Fluctuations," American Economic Review, American Economic Association, vol. 101(6), pages 2844-72, October.
  13. Harrison, J Michael & Kreps, David M, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, MIT Press, vol. 92(2), pages 323-36, May.
  14. Woodford, Michael, 2005. "Robustly optimal monetary policy with near-rational expectations," CFS Working Paper Series 2007/12, Center for Financial Studies (CFS).
  15. Martin L. Weitzman, 2007. "Subjective Expectations and Asset-Return Puzzles," American Economic Review, American Economic Association, vol. 97(4), pages 1102-1130, September.
  16. Robert J Aumann, 1999. "Agreeing to Disagree," Levine's Working Paper Archive 512, David K. Levine.
  17. Larry Blume & David Easley, 2001. "If You're So Smart, Why Aren't You Rich? Belief Selection in Complete and Incomplete Markets," Cowles Foundation Discussion Papers 1319, Cowles Foundation for Research in Economics, Yale University.
  18. Klaus Adam, 2003. "Learning and Equilibrium Selection in a Monetary Overlapping Generations Model with Sticky Prices," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 887-907.
  19. Lubos Pastor & Pietro Veronesi, 2002. "Stock Valuation and Learning about Profitability," NBER Working Papers 8991, National Bureau of Economic Research, Inc.
  20. 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.
  21. Cogley, Timothy & Sargent, Thomas J., 2008. "The market price of risk and the equity premium: A legacy of the Great Depression?," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 454-476, April.
  22. Krisztina Molnár & Sergio Santoro, 2010. "Optimal Monetary Policy When Agents Are Learning," Working Paper 2010/08, Norges Bank.
  23. Klaus Adam & Albert Marcet & Juan Pablo Nicolini, 2006. "Learning and Stock Market Volatility," Computing in Economics and Finance 2006 15, Society for Computational Economics.
  24. Thomas J Sargent, 2007. "Evolution and Intelligent Design," Levine's Bibliography 122247000000001821, UCLA Department of Economics.
  25. Geweke, John, 2001. "A note on some limitations of CRRA utility," Economics Letters, Elsevier, vol. 71(3), pages 341-345, June.
  26. Klaus Adam & Albert Marcet, 2011. "Booms and Busts in Asset Prices," CEP Discussion Papers dp1059, Centre for Economic Performance, LSE.
  27. Anderson, Robert M & Sonnenschein, Hugo, 1985. "Rational Expectations Equilibrium with Econometric Models," Review of Economic Studies, Wiley Blackwell, vol. 52(3), pages 359-69, July.
  28. Franklin Allen & Stephen Morris & Hyun Song Shin, 2006. "Beauty Contests and Iterated Expectations in Asset Markets," Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 719-752.
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:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

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:jetheo:v:146:y:2011:i:3:p:1224-1252. 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.