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Bubbles, Crashes and Risk

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Author Info

  • William A. Branch

    (University of California, Irvine)

  • George W. Evans

    ()
    (University of Oregon; University of St Andrews)

Abstract

In an asset-pricing model, risk-averse agents need to forecast the conditional variance of a stock's return. A near-rational restricted perceptions equilibrium exists in which agents believe prices follow a random walk with a conditional variance that is self-fulfilling. When agents estimate risk in real time, recurrent bubbles and crashes can arise. These effects are stronger when agents allow for ARCH in excess returns.

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File URL: http://www.st-andrews.ac.uk/economics/repecfiles/2/1306.pdf
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Bibliographic Info

Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 201306.

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Date of creation: 20 Mar 2013
Date of revision:
Handle: RePEc:san:cdmawp:1306

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Keywords: Risk; asset pricing; bubbles; adaptive learning;

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References

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  1. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August.
  2. Barsky, Robert B & De Long, J Bradford, 1993. "Why Does the Stock Market Fluctuate?," The Quarterly Journal of Economics, MIT Press, vol. 108(2), pages 291-311, May.
  3. William A. Branch & George W. Evans, 2011. "Learning about Risk and Return: A Simple Model of Bubbles and Crashes," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(3), pages 159-91, July.
  4. Robin Greenwood & Andrei Shleifer, 2013. "Expectations of Returns and Expected Returns," NBER Working Papers 18686, National Bureau of Economic Research, Inc.
  5. 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.
  6. Alan Greenspan, 2005. "Reflections on central banking," Speech 126, Board of Governors of the Federal Reserve System (U.S.).
  7. Gaunersdorfer, Andrea, 2000. "Endogenous fluctuations in a simple asset pricing model with heterogeneous agents," Journal of Economic Dynamics and Control, Elsevier, vol. 24(5-7), pages 799-831, June.
  8. Timmermann, Allan G, 1993. "How Learning in Financial Markets Generates Excess Volatility and Predictability in Stock Prices," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1135-45, November.
  9. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
  10. KevinJ. Lansing, 2010. "Rational and Near-Rational Bubbles Without Drift," Economic Journal, Royal Economic Society, vol. 120(549), pages 1149-1174, December.
  11. Paolo Gelain & Kevin J. Lansing, 2013. "House prices, expectations, and time-varying fundamentals," Working Paper Series 2013-03, Federal Reserve Bank of San Francisco.
  12. Marius Jurgilas & Kevin J. Lansing, 2012. "Housing bubbles and homeownership returns," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue jun25.
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Cited by:
  1. Zhu, Xiaoneng, 2013. "Perpetual learning and stock return predictability," Economics Letters, Elsevier, vol. 121(1), pages 19-22.
  2. Guharay, Samar K. & Thakur, Gaurav S. & Goodman, Fred J. & Rosen, Scott L. & Houser, Daniel, 2013. "Analysis of non-stationary dynamics in the financial system," Economics Letters, Elsevier, vol. 121(3), pages 454-457.

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