Asset Return Dynamics and Learning
Loading...
Date
2006-11-13
Authors
Branch, William A.
Evans, George W., 1949-
Journal Title
Journal ISSN
Volume Title
Publisher
University of Oregon, Dept of Economics
Abstract
This paper advocates a theory of expectation formation that incorporates
many of the central motivations of behavioral finance theory while retaining
much of the discipline of the rational expectations approach. We provide a
framework in which agents, in an asset pricing model, underparameterize their
forecasting model in a spirit similar to Hong, Stein, and Yu (2005) and Barberis,
Shleifer, and Vishny (1998), except that the parameters of the forecasting
model, and the choice of predictor, are determined jointly in equilibrium. We
show that multiple equilibria can exist even if agents choose only models that
maximize (risk-adjusted) expected profits. A real-time learning formulation
yields endogenous switching between equilibria. We demonstrate that a realtime
learning version of the model, calibrated to U.S. stock data, is capable of
reproducing many of the salient empirical regularities in excess return dynamics
such as under/overreaction, persistence, and volatility clustering.
Description
40 p.
Keywords
Asset pricing, Misspecification, Behavioral finance, Predictability, Adaptive learning