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Properties of equilibrium asset prices under alternative learning schemes

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  • Massimo Guidolin
  • Allan Timmerman

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

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2005-009.

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Date of creation: 2005
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Publication status: Published in Journal of Economic Dynamics and Control, January 2007, 31(1)
Handle: RePEc:fip:fedlwp:2005-009

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Keywords: Assets (Accounting) ; Rational expectations (Economic theory);

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Citations

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Cited by:
  1. Timmermann, Allan, 2008. "Elusive return predictability," International Journal of Forecasting, Elsevier, Elsevier, vol. 24(1), pages 1-18.
  2. Koulovatianos, Christos & Wieland, Volker, 2011. "Asset pricing under rational learning about rare disasters," IMFS Working Paper Series 46, Institute for Monetary and Financial Stability (IMFS), Goethe University Frankfurt.
  3. Christos Koulovatianos, 2014. "Strategic Exploitation of a Common-Property Resource Under Rational Learning About its Reproduction," CREA Discussion Paper Series 14-06, Center for Research in Economic Analysis, University of Luxembourg.
  4. Subrahmanyam, Avanidhar, 2008. "Learning from experience and trading volume," Review of Financial Economics, Elsevier, Elsevier, vol. 17(4), pages 245-260, December.
  5. Hommes, Cars & Zhu, Mei, 2014. "Behavioral learning equilibria," Journal of Economic Theory, Elsevier, vol. 150(C), pages 778-814.
  6. Massimo Guidolin, 2006. "High equity premia and crash fears - Rational foundations," Economic Theory, Springer, Springer, vol. 28(3), pages 693-708, 08.
  7. Christos Koulovatianos, 2011. "A Paradox of Environmental Awareness Campaigns," Levine's Working Paper Archive 786969000000000041, David K. Levine.
  8. Massimo Guidolin, 2005. "Pessimistic beliefs under rational learning: quantitative implications for the equity premium puzzle," Working Papers, Federal Reserve Bank of St. Louis 2005-005, Federal Reserve Bank of St. Louis.
  9. 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, Elsevier, vol. 31(6), pages 1910-1937, June.
  10. Fabio Milani, 2008. "Learning about the Interdependence between the Macroeconomy and the Stock Market," Working Papers 070819, University of California-Irvine, Department of Economics.
  11. Cars Hommes & Mei Zhu, 2013. "Behavioral Learning Equilibria," Tinbergen Institute Discussion Papers 13-014/II, Tinbergen Institute.
  12. James B. Bullard & Jacek Suda, 2008. "The stability of macroeconomic systems with Bayesian learners," Working Papers, Federal Reserve Bank of St. Louis 2008-043, Federal Reserve Bank of St. Louis.
  13. Subrahmanyam, Avanidhar, 2009. "Optimal financial education," Review of Financial Economics, Elsevier, Elsevier, vol. 18(1), pages 1-9, January.

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