Journal Article10.1017/s1365100501019071
Learning and excess volatility
35
TL;DR: Learning and excess volatility generate equilibria characterized by persistent excess volatility in returns to capital.
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Abstract: We introduce adaptive learning behavior into a general-equilibrium life-cycle economy with capital accumulation. Agents form forecasts of the rate of return to capital assets using least-squares autoregressions on past data. We show that, in contrast to the perfect-foresight dynamics, the dynamical system under learning possesses equilibria that are characterized by persistent excess volatility in returns to capital. We explore a quantitative case for theselearning equilibria. We use an evolutionary search algorithm to calibrate a version of the system under learning and show that this system can generate data that matches some features of the time-series data for U.S. stock returns and per-capita consumption. We argue that this finding provides support for the hypothesis that the observed excess volatility of asset returns can be explained by changes in investor expectations against a background of relatively small changes in fundamental factors.
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