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Limited Memory, Time-varying Expectations and Asset Pricing

Author

Listed:
  • Guido Ascari

    (University of Pavia)

  • Yifan Zhang

    (University of Oxford)

Abstract

We propose a theory of asset pricing based on limited memory and time-varying expectations. The former guarantees a tendency to revert to fundamentals. The latter induces `momentum' in asset prices and it is motivated by a novel empirical observation about a time-varying mapping from price-dividend ratio to return expectations in survey data. The simulated method of moments shows that the model quantitatively replicates a host of asset-pricing features, including equity premium, excess volatility, persistence of price-dividend ratio, predictability of excess returns and the consumption correlation puzzle. The model also generates empirically plausible subjective expectations.

Suggested Citation

  • Guido Ascari & Yifan Zhang, 2023. "Limited Memory, Time-varying Expectations and Asset Pricing," DEM Working Papers Series 211, University of Pavia, Department of Economics and Management.
    • Handle: RePEc:pav:demwpp:demwp0211
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    File URL: https://economiaemanagement.dip.unipv.it/sites/dip10/files/2022-12/DEMWP0211.pdf
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    More about this item

    Keywords

    Asset pricing; Expectations; Limited memory; Equity premium.;
    All these keywords.

    JEL classification:

    • G0 - Financial Economics - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G40 - Financial Economics - - Behavioral Finance - - - General

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