Limited Memory, Time-varying Expectations and Asset Pricing

Guido Ascari and Yifan Zhang

No 211, DEM Working Papers Series from University of Pavia, Department of Economics and Management

Abstract: We propose a theory of asset pricing based on limited memory and time-varying expectations. The former guarantees a tendency to revert to fundamentals. The latter induces `momentum' in asset prices and it is motivated by a novel empirical observation about a time-varying mapping from price-dividend ratio to return expectations in survey data. The simulated method of moments shows that the model quantitatively replicates a host of asset-pricing features, including equity premium, excess volatility, persistence of price-dividend ratio, predictability of excess returns and the consumption correlation puzzle. The model also generates empirically plausible subjective expectations.

Keywords: Asset pricing; Expectations; Limited memory; Equity premium. (search for similar items in EconPapers)
JEL-codes: G0 G12 G40 (search for similar items in EconPapers)
Pages: 76
Date: 2023-07
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