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Stock Market Volatility and Learning

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  • Adam, Klaus
  • Marcet, Albert
  • Nicolini, Juan Pablo

Abstract

Introducing bounded rationality into a standard consumption based asset pricing model with a representative agent and time separable preferences strongly improves empirical performance. Learning causes momentum and mean reversion of returns and thereby excess volatility, persistence of price-dividend ratios, long-horizon return predictability and a risk premium, as in the habit model of Campbell and Cochrane (1999), but for lower risk aversion. This is obtained, even though we restrict consideration to learning schemes that imply only small deviations from full rationality. The findings are robust to the particular learning rule used and the value chosen for the single free parameter introduced by learning, provided agents forecast future stock prices using past information on prices.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6518.

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Date of creation: Oct 2007
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Handle: RePEc:cpr:ceprdp:6518

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Related research

Keywords: asset pricing puzzles; consumption-based asset pricing; learning;

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References

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  1. Brock, William A. & Hommes, Cars H., 1998. "Heterogeneous beliefs and routes to chaos in a simple asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 22(8-9), pages 1235-1274, August.
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  5. repec:cup:macdyn:v:5:y:2001:i:2:p:272-302 is not listed on IDEAS
  6. Klaus Adam, 2003. "Learning and Equilibrium Selection in a Monetary Overlapping Generations Model with Sticky Prices," CFS Working Paper Series 2003/03, Center for Financial Studies.
  7. Albert Marcet & Klaus Adam & Juan Pablo Nicolini, 2008. "Stock Market Volatility and Learning," UFAE and IAE Working Papers 732.08, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  8. Klaus Adam & Albert Marcet, 2011. "Internal Rationality, Imperfect Market Knowledge and Asset Prices," CEP Discussion Papers dp1068, Centre for Economic Performance, LSE.
  9. 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.
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  13. Klaus Adam, 2001. "Learning and Equilibrium Selection in a Monetary Overlapping Generations Model with Sticky," CSEF Working Papers 69, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
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