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Asset Pricing with Adaptive Learning

  • Eva Carceles-Poveda

    (SUNY Stony Brook)

  • Chryssi Giannitsarou

    (University of Cambridge)

We study the extent to which self-referential adaptive learning can explain stylized asset pricing facts in a general equilibrium framework. In particular, we analyze the effects of recursive least squares and constant gain algorithms in a production economy and a Lucas type endowment economy. We find that (a) recursive least squares learning has almost no effects on asset price behavior, since the algorithm converges relatively fast to rational expectations, (b) constant gain learning may contribute towards explaining the stock price and return volatility as well as the predictability of excess returns in the endowment economy but (c) in the production economy the effects of constant gain learning are mitigated by the persistence induced by capital accumulation. We conclude that in the context of these two commonly used models, standard linear self-referential learning does not resolve the asset pricing puzzles observed in the data. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2007.10.003
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 11 (2008)
Issue (Month): 3 (July)
Pages: 629-651

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Handle: RePEc:red:issued:06-119
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Marina Azzimonti, Department of Economics, Stonybrook University, 10 Nicolls Road, Stonybrook NY 11790 USA

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  1. Giannitsarou, Chryssi, 2005. "E-Stability Does Not Imply Learnability," Macroeconomic Dynamics, Cambridge University Press, vol. 9(02), pages 276-287, April.
  2. Campbell, John & Shiller, Robert, 1988. "Stock Prices, Earnings, and Expected Dividends," Scholarly Articles 3224293, Harvard University Department of Economics.
  3. Brennan, Michael J. & Xia, Yihong, 2001. "Stock price volatility and equity premium," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 249-283, April.
  4. Kocherlakota, N., 1995. "The Equity Premium: It's Still a Puzzle," Working Papers 95-05, University of Iowa, Department of Economics.
  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.
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  19. Allan Timmermann, 1996. "Excess Volatility and Predictability of Stock Prices in Autoregressive Dividend Models with Learning," Review of Economic Studies, Oxford University Press, vol. 63(4), pages 523-557.
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