Learning about Risk and Return: A Simple Model of Bubbles and Crashes
Loading...
Date
2008-01-31
Authors
Branch, William A.
Evans, George W., 1949-
Journal Title
Journal ISSN
Volume Title
Publisher
University of Oregon, Dept of Economics
Abstract
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.
Description
42 p.
Keywords
Risk, Asset pricing, Bubbles, Adaptive learning, Stocks -- Prices