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Heterogeneous Beliefs, Risks and Learning in a Simple Asset Pricing Model

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Abstract

Trade among individuals occurs either because tastes (risk aversion) differ, endowments differ, or beliefs differ. Utilisating the concept of :adaptively rational equilibrium" and a recent framework of Brock and Hommes [6, 7], this paper incorporates risk and learning schemes into a simple discounted present value asset price model with heterogeneous beliefs. Agents have different risk aversion coefficients and adapt their beliefs (about future returns) over time by choosing from different predictors or expectations functions, based upon their past performance as measured by realized profits. By using both bifurcation theory and numerical analysis, it is found that the dynamics of asset pricing is affected by the relative risk attitudes of different types of investors. It is also found that the external noise and learning schemes can significantly affect the dynamics. Compared with the findings of Brock and Hommes [7] on the dynamics caused by chage of the intensity of choice to switch predictors, it is found that many of their insights are robust to the generalizations considered; however, the resulting dynamical behavior is considerably enriched and exhibits some significant differences.

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File URL: http://www.business.uts.edu.au/qfrc/research/research_papers/rp18.pdf
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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 18.

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Date of creation: 01 Aug 1999
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Handle: RePEc:uts:rpaper:18

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  1. 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.
  2. Franke, Reiner & Sethi, Rajiv, 1998. "Cautious trend-seeking and complex asset price dynamics," Research in Economics, Elsevier, vol. 52(1), pages 61-79, March.
  3. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, . "Noise Trader Risk in Financial Markets," J. Bradford De Long's Working Papers _124, University of California at Berkeley, Economics Department.
  4. repec:att:wimass:9530 is not listed on IDEAS
  5. Brock, W.A. & Hommes, C.H., 1996. "A Rational Route to Randomness," Working papers 9530r, Wisconsin Madison - Social Systems.
  6. James M. Poterba & Lawrence H. Summers, 1987. "Mean Reversion in Stock Prices: Evidence and Implications," NBER Working Papers 2343, National Bureau of Economic Research, Inc.
  7. Day, Richard H. & Huang, Weihong, 1990. "Bulls, bears and market sheep," Journal of Economic Behavior & Organization, Elsevier, vol. 14(3), pages 299-329, December.
  8. Kyle, Albert & Campbell, John, 1993. "Smart Money, Noise Trading and Stock Price Behaviour," Scholarly Articles 3208217, Harvard University Department of Economics.
  9. Carl Chiarella, 1992. "The Dynamics of Speculative Behaviour," Working Paper Series 13, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  10. Giulia Iori, 1999. "A microsimulation of traders activity in the stock market: the role of heterogeneity, agents' interactions and trade frictions," Finance 9905005, EconWPA.
  11. repec:att:wimass:9706 is not listed on IDEAS
  12. Lux, Thomas, 1998. "The socio-economic dynamics of speculative markets: interacting agents, chaos, and the fat tails of return distributions," Journal of Economic Behavior & Organization, Elsevier, vol. 33(2), pages 143-165, January.
  13. Lux, Thomas, 1997. "Time variation of second moments from a noise trader/infection model," Journal of Economic Dynamics and Control, Elsevier, vol. 22(1), pages 1-38, November.
  14. Summers, Lawrence H, 1986. " Does the Stock Market Rationally Reflect Fundamental Values?," Journal of Finance, American Finance Association, vol. 41(3), pages 591-601, July.
  15. Reiner Franke & Tim Nesemann, 1999. "Two destabilizing strategies may be jointly stabilizing," Journal of Economics, Springer, vol. 69(1), pages 1-18, February.
  16. Sanford Grossman, 1989. "The Informational Role of Prices," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262572141, December.
  17. Sethi, Rajiv, 1996. "Endogenous regime switching in speculative markets," Structural Change and Economic Dynamics, Elsevier, vol. 7(1), pages 99-118, March.
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