IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Learning about Risk and Return: A Simple Model of Bubbles and Crashes

Listed author(s):
  • Wiliam Branch

    (University of Californis - Irvine)

  • George W. Evans

    ()

    (University of Oregon Economics Department)

This paper demonstrates that an asset pricing model with least-squares learning can lead to bubbles and crashes as endogenous responses to the fundamentals driving asset prices. When agents are risk-averse they generate forecasts of the conditional variance of a stock's return. Recursive updating of the conditional variance and expected return implies two mechanisms through which learning impacts stock prices: occasional shocks may lead agents to lower their risk estimate and increase their expected return, thereby triggering a bubble; along a bubble path recursive estimates of risk will increase and crash the bubble.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://economics.uoregon.edu/papers/UO-2008-1_Evans_Crash.pdf
Download Restriction: no

Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2008-1.

as
in new window

Length:
Date of creation:
Handle: RePEc:ore:uoecwp:2008-1
Contact details of provider: Postal:
1285 University of Oregon, 435 PLC, Eugene, OR 97403-1285

Phone: (541) 346-8845
Fax: (541) 346-1243
Web page: http://economics.uoregon.edu/
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as
in new window

  1. Albert Marcet & Juan P. Nicolini, 1995. "Recurrent hyperinflations and learning," Economics Working Papers 244, Department of Economics and Business, Universitat Pompeu Fabra, revised Nov 2001.
  2. George W. Evans & Seppo Honkapohja, 1998. "Economic Dynamics with Learning: New Stability Results," Review of Economic Studies, Oxford University Press, vol. 65(1), pages 23-44.
  3. Geweke, John, 2001. "A note on some limitations of CRRA utility," Economics Letters, Elsevier, vol. 71(3), pages 341-345, June.
  4. Robert C. Merton, 1980. "On Estimating the Expected Return on the Market: An Exploratory Investigation," NBER Working Papers 0444, National Bureau of Economic Research, Inc.
  5. GRANDMONT, Jean-Michel, 1997. "Expectations formation and stability of large socioeconomic systems," CORE Discussion Papers 1997088, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  6. Wiliam Branch & George W. Evans, 2005. "A Simple Recursive Forecasting Model," University of Oregon Economics Department Working Papers 2005-3, University of Oregon Economics Department, revised 01 Feb 2005.
  7. In-Koo Cho & Noah Williams & Thomas J. Sargent, 2002. "Escaping Nash Inflation," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 1-40.
  8. Harrison Hong & José Scheinkman & Wei Xiong, 2006. "Asset Float and Speculative Bubbles," Journal of Finance, American Finance Association, vol. 61(3), pages 1073-1117, 06.
  9. In-Koo Cho & Kenneth Kasa, 2003. "Learning Dynamics and Endogenous Currency Crises," Computing in Economics and Finance 2003 132, Society for Computational Economics.
  10. Eli Ofek & Matthew Richardson, 2003. "DotCom Mania: The Rise and Fall of Internet Stock Prices," Journal of Finance, American Finance Association, vol. 58(3), pages 1113-1138, 06.
  11. Eva Carceles Poveda & Chryssi Giannitsarou, 2006. "Asset pricing with adaptive learning," Computing in Economics and Finance 2006 25, Society for Computational Economics.
  12. Bruce McGough, 2003. "Shocking Escapes," Computing in Economics and Finance 2003 294, Society for Computational Economics.
  13. Allen F. & Morris S. & Postlewaite A., 1993. "Finite Bubbles with Short Sale Constraints and Asymmetric Information," Journal of Economic Theory, Elsevier, vol. 61(2), pages 206-229, December.
  14. Manuel S. Santos & Michael Woodford, 1997. "Rational Asset Pricing Bubbles," Econometrica, Econometric Society, vol. 65(1), pages 19-58, January.
  15. Volker Bohm & Carl Chiarella, 2000. "Mean Variance Preferences, Expectations Formation, and the Dynamics of Random Asset Prices," Research Paper Series 46, Quantitative Finance Research Centre, University of Technology, Sydney.
  16. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
  17. Thomas Sargent & Noah Williams & Tao Zha, 2009. "The Conquest of South American Inflation," Journal of Political Economy, University of Chicago Press, vol. 117(2), pages 211-256, 04.
  18. Evans, George W, 1991. "Pitfalls in Testing for Explosive Bubbles in Asset Prices," American Economic Review, American Economic Association, vol. 81(4), pages 922-930, September.
  19. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  20. Martin L. Weitzman, 2007. "Subjective Expectations and Asset-Return Puzzles," American Economic Review, American Economic Association, vol. 97(4), pages 1102-1130, September.
  21. Klaus Adam & Albert Marcet & Juan Pablo Nicolini, 2006. "Learning and Stock Market Volatility," Computing in Economics and Finance 2006 15, Society for Computational Economics.
  22. Harrison Hong & Jose A. Scheinkman & Wei Xiong, 2007. "Advisors and Asset Prices: A Model of the Origins of Bubbles," NBER Working Papers 13504, National Bureau of Economic Research, Inc.
  23. Kenneth D. West, 1987. "A Specification Test for Speculative Bubbles," The Quarterly Journal of Economics, Oxford University Press, vol. 102(3), pages 553-580.
  24. Froot, Kenneth A & Obstfeld, Maurice, 1991. "Intrinsic Bubbles: The Case of Stock Prices," American Economic Review, American Economic Association, vol. 81(5), pages 1189-1214, December.
  25. Jonathan Lewellen & Jay Shanken, 2002. "Learning, Asset-Pricing Tests, and Market Efficiency," Journal of Finance, American Finance Association, vol. 57(3), pages 1113-1145, 06.
  26. Timmermann, Allan, 1994. "Can Agents Learn to Form Rational Expectations? Some Results on Convergence and Stability of Learning in the UK Stock Market," Economic Journal, Royal Economic Society, vol. 104(425), pages 777-797, July.
  27. 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.
  28. Blanchard, Olivier Jean, 1979. "Speculative bubbles, crashes and rational expectations," Economics Letters, Elsevier, vol. 3(4), pages 387-389.
Full references (including those not matched with items on IDEAS)

This item is featured on the following reading lists or Wikipedia pages:

  1. Learning about Risk and Return: A Simple Model of Bubbles and Crashes (AEJ:MA 2011) in ReplicationWiki

When requesting a correction, please mention this item's handle: RePEc:ore:uoecwp:2008-1. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Bill Harbaugh)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.