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Learning the CAPM through Bubbles

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  • Haim Kedar-Levy
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    Abstract

    Bubbles are generally considered the outcome of investor irrationality or informational asymmetry, both objectionable in efficient markets with rational investors. We introduce an Intertemporal-CAPM with market clearing between high- and low-risk-averse rational investors who learn the CAPM under incomplete, yet symmetric information. Periodic equilibrium prices make a lognormal price process that nests the classic CAPM with a potential for endogenous bubbles through learning. The absence of comparables through the introductory phase of new technologies results in unstable return dynamics that might burst to bubbles or decline to near-zero, “pink-sheet†valuations. When the technology shifts phase to generate real profits the return dynamics is convergent, revealing the classic CAPM. Once the real technology return is observable, over- and under-pricing can be assessed, resulting in prompt positive or negative price adjustments toward the CAPM valuation. Correspondence with the Abreu and Brunnermeier (2003) model of bubbles with rational arbitrageurs is presented as well.

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    Bibliographic Info

    Paper provided by Econometric Society in its series Econometric Society 2004 Far Eastern Meetings with number 775.

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    Date of creation: 11 Aug 2004
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    Handle: RePEc:ecm:feam04:775

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    Keywords: ICAPM; Bubbles; New Technologies; Rational Expectations;

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