Bounded rationality, adaptive behaviour, and asset prices

Dongxu Zhao and Kai Li

International Review of Financial Analysis, 2022, vol. 80, issue C

Abstract: This paper develops a simple heterogeneous agent model (HAM) of asset prices with bounded rationality and adaptive behaviour. The model features feedback loop that amplifies shocks and leads to large price fluctuations. Our model not only retains the nonlinear interaction between prices and population in HAMs but also allows for a quantitative comparison with the data. Estimating the model to the data shows that the feedback loop helps explain the large variations in expected returns, such as return predictability and excess volatility.

Keywords: Bounded rationality; Adaptive behaviour; Feedback; Regime switching; Estimation; Heterogeneity (search for similar items in EconPapers)
JEL-codes: C13 C51 G12 G41 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:80:y:2022:i:c:s1057521922000163

DOI: 10.1016/j.irfa.2022.102037

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