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Endogenous Rational Bubbles

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  • George A. Waters

    ()
    (Department of Economics, Illinois State University)

Abstract

Tests on simulated data from an asset pricing model with heterogeneous forecasts show excess variance in the price and ARCH effects in the returns, features not explained by the strong version of the efficient markets hypothesis. An evolutionary game theory dynamic describes how agents switch between a fundamental forecast, a rational bubble forecast and the reflective forecast, which is a weighted average of the former two. Conditions determining the frequency and duration of episodes where a significant fraction of agents adopt the rational bubble forecast leading to large deviations in the price-dividend ratio are discussed.

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File URL: http://economics.illinoisstate.edu/RePec/Papers/EndogenousRationalBubbles10-11.pdf
File Function: First version, 2011
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Bibliographic Info

Paper provided by Illinois State University, Department of Economics in its series Working Paper Series with number 20111003.

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Length: 32 pages
Date of creation: Oct 2011
Date of revision:
Handle: RePEc:ils:wpaper:20111003

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Web page: http://economics.illinoisstate.edu

Related research

Keywords: return predictability; excess variance; ARCH; evolutionary game theory; rational bubble;

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  1. Adam, Klaus & Marcet, Albert & Nicolini, Juan Pablo, 2008. "Stock market volatility and learning," Working Paper Series 0862, European Central Bank.
  2. Hommes, C.H., 2000. "Financial Markets as Nonlinear Adaptive Evolutionary Systems," CeNDEF Working Papers 00-03, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  3. KevinJ. Lansing, 2010. "Rational and Near-Rational Bubbles Without Drift," Economic Journal, Royal Economic Society, vol. 120(549), pages 1149-1174, December.
  4. 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.
  5. Hofbauer, Josef & Weibull, Jörgen W., 1995. "Evolutionary Selection against Dominated Strategies," Working Paper Series 433, Research Institute of Industrial Economics.
  6. Charemza, Wojciech W. & Deadman, Derek F., 1995. "Speculative bubbles with stochastic explosive roots: The failure of unit root testing," Journal of Empirical Finance, Elsevier, vol. 2(2), pages 153-163, June.
  7. Evans, George W, 1991. "Pitfalls in Testing for Explosive Bubbles in Asset Prices," American Economic Review, American Economic Association, vol. 81(4), pages 922-30, September.
  8. Weibull, Jörgen W., 1997. "What have we learned from Evolutionary Game Theory so far?," Working Paper Series 487, Research Institute of Industrial Economics, revised 26 Oct 1998.
  9. Cars H. Hommes, 2001. "Financial Markets as Nonlinear Adaptive Evolutionary Systems," Tinbergen Institute Discussion Papers 01-014/1, Tinbergen Institute.
  10. Parke, William R. & Waters, George A., 2007. "An evolutionary game theory explanation of ARCH effects," Journal of Economic Dynamics and Control, Elsevier, vol. 31(7), pages 2234-2262, July.
  11. Blanchard, Olivier J, 1979. "Backward and Forward Solutions for Economies with Rational Expectations," American Economic Review, American Economic Association, vol. 69(2), pages 114-18, May.
  12. Waters, George A., 2009. "Chaos in the cobweb model with a new learning dynamic," Journal of Economic Dynamics and Control, Elsevier, vol. 33(6), pages 1201-1216, June.
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