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Equilibrium Stock Return Dynamics Under Alternative Rules of Learning About Hidden States

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  • Michael Brandt, Qi Zeng and Lu Zhang
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Abstract

We examine the dynamic properties of equilibrium stock returns in an incomplete information economy in which the agents need to learn the hidden state of the endowment process. We consider both the case of optimal Bayesian learning and suboptimal learning, including near-rational learning, over- or under-confidence, optimism or pessimism, adaptive learning, and limited memory. We find that Bayesian learning can quantitatively explain short-run momentum, long-run mean-reversion, predictability, volatility clustering, and leverage effects in stock returns. Only over-confidence can marginally improve some aspects of the model (add short-run momentum) without substantially deteriorating other aspects. We conclude that the success of the incomplete information model is quite dependent on optimally learning agents.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2001 with number 41.

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Date of creation: 01 Apr 2001
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Handle: RePEc:sce:scecf1:41

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Keywords: equilibrium stock return; learning rules; regime switching;

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Cited by:
  1. Cogley, Timothy & Sargent, Thomas J., 2008. "The market price of risk and the equity premium: A legacy of the Great Depression?," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 454-476, April.
  2. Nengjiu Ju & Jianjun Miao, . "Ambiguity, Learning, and Asset Returns," Boston University - Department of Economics - Working Papers Series wp2009-014, Boston University - Department of Economics.
  3. Massimo Guidolin & Allan Timmerman, 2005. "Properties of equilibrium asset prices under alternative learning schemes," Working Papers 2005-009, Federal Reserve Bank of St. Louis.
  4. Tim W. Cogley & Thomas J. Sargent, 2005. "The Market Price of Risk and the Equity Premium," Working Papers 522, University of California, Davis, Department of Economics.
  5. Collard, Fabrice & Fève, Patrick & Ghattassi, Imen, 2006. "Predictability and Habit Persistence," Open Access publications from University of Toulouse 1 Capitole http://neeo.univ-tlse1.fr, University of Toulouse 1 Capitole.
  6. Larry Epstein & Martin Schneider, 2006. "Learning Under Ambiguity," RCER Working Papers 527, University of Rochester - Center for Economic Research (RCER).
  7. Massa, Massimo & Simonov, Andrei, 2005. "Is learning a dimension of risk?," Journal of Banking & Finance, Elsevier, vol. 29(10), pages 2605-2632, October.
  8. Larry G. Epstein & Martin Schneider, 2008. "Ambiguity, Information Quality, and Asset Pricing," Journal of Finance, American Finance Association, vol. 63(1), pages 197-228, 02.
  9. Bidarkota, Prasad V. & Dupoyet, Brice V. & McCulloch, J. Huston, 2009. "Asset pricing with incomplete information and fat tails," Journal of Economic Dynamics and Control, Elsevier, vol. 33(6), pages 1314-1331, June.
  10. Yiqun Mou & Lars A. Lochstoer & Michael Johannes, 2011. "Learning about Consumption Dynamics," 2011 Meeting Papers 306, Society for Economic Dynamics.

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