Portfolio Choice and Asset Prices in an Economy Populated by Case-Based Decision Makers

Abstract:     
I consider an economy populated by case-based decision makers. Consumption can be transferred between the periods by means of a riskless storage technology or a risky asset with i.i.d. dividend payments. I analyze the dynamics of asset holdings and asset prices and identify the influence of the aspiration level, the length of memory and the form of the similarity function. The height of the aspiration level determines whether the economy exhibits constant prices and asset holdings or evolves in a cycle. The length of memory is associated with the ability of the investors to learn the correct distribution of returns, whereas the form of the similarity function influences the willingness of investors to diversify.

Number of Pages in PDF File: 47

Keywords: case-based decision theory, financial markets, asset pricing

JEL Classification: D81, G12

working papers series