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

William Branch and George Evans

American Economic Journal: Macroeconomics, 2011, vol. 3, issue 3, 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)

JEL-codes: D81 D83 E32 G01 G12 (search for similar items in EconPapers)
Date: 2011
Note: DOI: 10.1257/mac.3.3.159
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Citations: View citations in EconPapers (109)

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Related works:
Working Paper: Learning about Risk and Return: A Simple Model of Bubbles and Crashes (2010)
Working Paper: Learning about Risk and Return: A Simple Model of Bubbles and Crashes
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