American Economic Journal:
Macroeconomics
ISSN 1945-7707 (Print) | ISSN 1945-7715 (Online)
Learning about Risk and Return: A Simple Model of Bubbles and Crashes
American Economic Journal: Macroeconomics
vol. 3,
no. 3, July 2011
(pp. 159–91)
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 need to make forecasts of the conditional variance of a stock's return. Recursive updating of both the conditional variance and the expected return implies several mechanisms through which learning impacts stock prices. Extended periods of excess volatility, bubbles, and crashes arise with a frequency that depends on the extent to which past data is discounted. A central role is played by changes over time in agents' estimates of risk. (JEL D81, D83, E32, G01, G12)Citation
Branch, William A., and George W. Evans. 2011. "Learning about Risk and Return: A Simple Model of Bubbles and Crashes." American Economic Journal: Macroeconomics, 3 (3): 159–91. DOI: 10.1257/mac.3.3.159Additional Materials
JEL Classification
- D81 Criteria for Decision-Making under Risk and Uncertainty
- D83 Search; Learning; Information and Knowledge; Communication; Belief
- E32 Business Fluctuations; Cycles
- G01 Financial Crises
- G12 Asset Pricing; Trading volume; Bond Interest Rates
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