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Stock Market Volatility and Learning

  • Adam, Klaus
  • Marcet, Albert
  • Nicolini, Juan Pablo

We study a standard consumption based asset pricing model with rational investors who entertain subjective prior beliefs about price behavior. Optimal behavior then dictates that investors learn about price behavior from past price observations. We show that this imparts momentum and mean reversion into the equilibrium behavior of the price dividend ratio, similar to what can be observed in the data. Estimating the model on U.S. stock price data using the method of simulated moments, we show that it can quantitatively account for the observed stock price volatility, the persistence of the price-dividend ratio, and the predictability of long-horizon returns. For reasonable degrees of risk aversion, the model also passes a formal statistical test for the overall goodness of fit, provided one excludes the equity premium from the set of moments to be matched.

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File URL: https://ub-madoc.bib.uni-mannheim.de/31217/4/Stock_Market_Volatility_and_Learning.pdf
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Paper provided by University of Mannheim, Department of Economics in its series Working Papers with number 12-06.

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Date of creation: 2012
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Handle: RePEc:mnh:wpaper:31217
Contact details of provider: Postal: 68131 Mannheim
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  5. Adam, Klaus & Marcet, Albert & Nicolini, Juan Pablo, 2008. "Stock market volatility and learning," Working Paper Series 0862, European Central Bank.
  6. Klaus Adam, 2003. "Learning and Equilibrium Selection in a Monetary Overlapping Generations Model with Sticky Prices," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 887-907.
  7. Hans Joachim Voth, 2000. "With a bang, not a whimper: Pricking Germany's "stock market bubble" in 1927 and the slide into depression," Economics Working Papers 516, Department of Economics and Business, Universitat Pompeu Fabra.
  8. Fabrice Collard & Sujoy Mukerji & Kevin Sheppard & Jean-Marc Tallon, 2011. "Ambiguity and the historical equity premium," Documents de travail du Centre d'Economie de la Sorbonne 11032, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
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