Booms and busts in asset prices

Klaus Adam and Albert Marcet

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We show how low-frequency boom and bust cycles in asset prices can emerge from Bayesian learning by investors. Investors rationally maximize infinite horizon utility but hold subjective priors about the asset return process that we allow to differ infinitesimally from the rational expectations prior. Bayesian updating of return beliefs then gives rise to selfreinforcing return optimism that results in an asset price boom. The boom endogenously comes to an end because return optimism causes investors to make optimistic plans about future consumption. The latter reduces the demand for assets that allow to intertemporally transfer resources. Once returns fall short of expectations, investors revise return expectations downward and set in motion a self-reinforcing price bust. In line with available survey data, the learning model predicts return optimism to comove positively with market valuation. In addition, the learning model replicates the low frequency behavior of the U.S. price dividend ratio over the period 1926-2006.

Keywords: asset price fluctuations; boom and bust cycles (search for similar items in EconPapers)
JEL-codes: D84 G12 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2011-07-01
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://eprints.lse.ac.uk/121706/ Open access version. (application/pdf)

Related works:
Working Paper: Booms and Busts in Asset Prices (2011)
Working Paper: Booms and Busts in Asset Prices (2010)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:121706

Access Statistics for this paper

More papers in LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library LSE Library Portugal Street London, WC2A 2HD, U.K.. Contact information at EDIRC.
Bibliographic data for series maintained by LSERO Manager ().