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

  • Chiarella, Carl
  • He, Xue-Zhong

Trade among individuals occurs either because tastes (risk aversion) differ, endowments differ, or beliefs differ. Utilising the concept of "adaptively rational equilibrium" and a recent framework of Brock and Hommes (1977, 1997) 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 (1998) on the dynamics caused by change 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. Copyright 2002 by Kluwer Academic Publishers

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Article provided by Society for Computational Economics in its journal Computational Economics.

Volume (Year): 19 (2002)
Issue (Month): 1 (February)
Pages: 95-132

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Handle: RePEc:kap:compec:v:19:y:2002:i:1:p:95-132
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  1. Brock, W.A., 1995. "A Rational Route to Randomness," Working papers 9530, Wisconsin Madison - Social Systems.
  2. Kyle, Albert & Campbell, John, 1993. "Smart Money, Noise Trading and Stock Price Behaviour," Scholarly Articles 3208217, Harvard University Department of Economics.
  3. Giulia Iori, 1999. "A microsimulation of traders activity in the stock market: the role of heterogeneity, agents' interactions and trade frictions," Finance 9905005, EconWPA.
  4. Sethi, Rajiv, 1996. "Endogenous regime switching in speculative markets," Structural Change and Economic Dynamics, Elsevier, vol. 7(1), pages 99-118, March.
  5. 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.
  6. 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.
  7. 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.
  8. 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.
  9. Franke, Reiner & Sethi, Rajiv, 1998. "Cautious trend-seeking and complex asset price dynamics," Research in Economics, Elsevier, vol. 52(1), pages 61-79, March.
  10. Reiner Franke & Tim Nesemann, 1999. "Two destabilizing strategies may be jointly stabilizing," Journal of Economics, Springer, vol. 69(1), pages 1-18, February.
  11. Carl Chiarella, 1992. "The Dynamics of Speculative Behaviour," Working Paper Series 13, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  12. Sanford Grossman, 1989. "The Informational Role of Prices," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262572141.
  13. 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.
  14. 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.
  15. Day, R. & Huang, W., 1988. "Bulls, Bears And Market Sheep," Papers m8822, Southern California - Department of Economics.
  16. Brock, W.A. & Hommes, C.H., 1997. "Models of Compelxity in Economics and Finance," Working papers 9706, Wisconsin Madison - Social Systems.
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