Asset Pricing with Experience Effects

Ulrike Malmendier, Demian Pouzo and Victoria Vanasco (vvanasco@crei.cat)
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Ulrike Malmendier: University of CA, Berkeley
Demian Pouzo: University of CA, Berkeley

Research Papers from Stanford University, Graduate School of Business

Abstract: How does the experience of a financial crisis and stock-market fluctuations alter the dynamics of financial markets? Recent evidence suggests that individuals overweight personal experiences of macroeconomic shocks when forming beliefs about risky outcomes and making investment decisions. We propose a simple OLG model of experience-based learning where risk averse agents can invest in risky and risk-free assets. They form beliefs about the payoff of the risky asset (1) based on data observed during their lifetimes so far and (2) exhibiting recency bias, the two components of experience effects. We show that, in equilibrium, prices depend on past dividends, but only those observed by the generations that are alive, and they are more sensitive to more recent dividends. Younger generations react more strongly to recent experiences than older generations and, hence, have higher demand for the risky asset than the old in good times, and lower demand in bad times. The model generates predictions for stock-market dynamics and trading volume: First, a recent crisis will increase the average age of agents holding stocks, while booms would have the opposite effect. Second, the stronger the disagreement across generations (e.g. after a recent shock), the higher is the trade volume. We provide stylized facts from the Survey of Consumer Finances consistent with these predictions.

Date: 2016-05
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