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Asset pricing with flexible beliefs

Asset pricing with flexible beliefs Abstract We develop a present-value asset pricing model with an econometrically useful representation that accommodates a plethora of stylized assumptions about beliefs. Using 20th century S&P500 data we use our model to compare the empirical fit of belief assumptions associated with rational expectations, asymmetic information, learning, behavioral effects and evolution. Among these, asymmetric information with evolution is particularly useful both in terms of statistical criteria and in terms of ability to explain the equity premium, excess volatility and predictability of returns. Our work suggests that popular relaxations of rationality can easily lead to econometric representations that may be impossible to work with in empirical research. Furthermore, replication of stylized facts may be too weak a requirement when evaluating such models. Fortunately, there exist simple relaxations of rationality that are sufficient to drastically improve the empirical fit of models with full rationality. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Studies in Nonlinear Dynamics & Econometrics de Gruyter

Asset pricing with flexible beliefs

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Publisher
de Gruyter
Copyright
Copyright © 2015 by the
ISSN
1081-1826
eISSN
1558-3708
DOI
10.1515/snde-2013-0110
Publisher site
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Abstract

Abstract We develop a present-value asset pricing model with an econometrically useful representation that accommodates a plethora of stylized assumptions about beliefs. Using 20th century S&P500 data we use our model to compare the empirical fit of belief assumptions associated with rational expectations, asymmetic information, learning, behavioral effects and evolution. Among these, asymmetric information with evolution is particularly useful both in terms of statistical criteria and in terms of ability to explain the equity premium, excess volatility and predictability of returns. Our work suggests that popular relaxations of rationality can easily lead to econometric representations that may be impossible to work with in empirical research. Furthermore, replication of stylized facts may be too weak a requirement when evaluating such models. Fortunately, there exist simple relaxations of rationality that are sufficient to drastically improve the empirical fit of models with full rationality.

Journal

Studies in Nonlinear Dynamics & Econometrics – de Gruyter

Published: Sep 1, 2015

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    Shleifer
  • Learning About Beta Time - Varying Factor Loadings Expected Returns and the Conditional of Empirical
    Adrian
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    Brandt
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    Kahneman
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  • Asymptotic Properties of Quasi - Maximum Likelihood Estimators for ARMA Models with Time - Dependent Coefficients Statistical Inference for Stochastic Processes
    Azrak
  • Market Volatility MIT Massachusetts Institute of Technology
    Shiller
  • Model of Investor Sentiment of
    Barberis
  • Subjective Probability Judgement of Representativeness Cognitive Psychological
    Kahneman
  • An Exploration of the Effects of Pessimism and Doubt on Asset Returns of Economic Dynamics and
    Abel
  • Mean Reversion in Equilibrium Asset Prices
    Cecchetti
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    Bansal
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    Hussman
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    Gourieroux
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    Brock
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    Sargent
  • Asset Pricing with Distorted Beliefs : Are Equity Returns Too Good to Be True
    Cecchetti
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    Shiller
  • Recurrent Learning The
    Marcet
  • Convergence of Least - Squares Learning in Environments with Hidden State Variables and Private of
    Marcet
  • Equilibrium Stock Return Dynamics under Alternative Rules of Learning About Hidden States of Economic Dynamics and
    Brandt
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    Clarke
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    Brock
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    LeBaron
  • Formulating and Estimating Dynamic Linear Rational Expectations Models of Economic Dynamics and
    Hansen
  • On Technical of
    Brown
  • Risks for the Long Run Potential Resolution of Asset Pricing Puzzles of
    Bansal
  • Asset Pricing and Wealth Dynamics under Heterogeneous Expectations
    Chiarella
  • Expectation Calculation The
    Evans
  • Bayesian of Models
    Ahn
  • Irrational Expectations and Econometric Practice : Discussion of Orphanides Inflation Scares and Forecast - Based Monetary Federal Reserve Bank of Atlanta Working Paper
    Ireland