Behavioral Heterogeneity in Stock Prices

40 Pages Posted: 4 Feb 2009

See all articles by H. Peter Boswijk

H. Peter Boswijk

Amsterdam School of Economics; Tinbergen Institute

Cars H. Hommes

University of Amsterdam - Amsterdam School of Economics (ASE); CeNDEF; Tinbergen Institute

Sebastiano Manzan

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Multiple version iconThere are 2 versions of this paper

Date Written: June 2006

Abstract

We estimate a dynamic asset pricing model characterized by heterogeneous boundedly rational agents. The fundamental value of the risky asset is publicly available to all agents, but they have different beliefs about the persistence of deviations of stock prices from the fundamental benchmark. An evolutionary selection mechanism based on relative past profits governs the dynamics of the fractions and switching of agents between different beliefs or forecasting strategies. A strategy attracts more agents if it performed relatively well in the recent past compared to other strategies. We estimate the model to annual US stock price data from 1871 until 2003. The estimation results support the existence of two expectation regimes, and a bootstrap F-test rejects linearity in favor of our nonlinear two-type heterogeneous agent model. One regime can be characterized as a fundamentalists regime, because agents believe in mean reversion of stock prices toward the benchmark fundamental value. The second regime can be characterized as a chartist, trend following regime because agents expect the deviations from the fundamental to trend. The fractions of agents using the fundamentalists and trend following forecasting rules show substantial time variation and switching between predictors. The model offers an explanation for the recent stock prices run-up. Before the 90s the trend following regime was active only occasionally. However, in the late 90s the trend following regime persisted and created an extraordinary deviation of stock prices from the fundamentals. Recently, the activation of the mean reversion regime has contributed to drive stock prices back closer to their fundamental valuation.

Keywords: heterogeneous expectations, stock prices, bubbles, bounded rationality

JEL Classification: G12, C22

Suggested Citation

Boswijk, H. Peter and Hommes, Cars H. and Manzan, Sebastiano, Behavioral Heterogeneity in Stock Prices (June 2006). Journal of Economic Dynamics and Control, Vol. 31, 2007. Available at SSRN: https://ssrn.com/abstract=1269050

H. Peter Boswijk

Amsterdam School of Economics ( email )

Roetersstraat 11
Amsterdam, North Holland 1018 WB
Netherlands

HOME PAGE: http://www.uva.nl/profile/h.p.boswijk

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Cars H. Hommes

University of Amsterdam - Amsterdam School of Economics (ASE) ( email )

Center for Nonlinear Dynamics in Economics and Finance
1018 WB Amsterdam
Netherlands
+31 20 525 4246 (Phone)
+31 20 525 4349 (Fax)

CeNDEF ( email )

Roetersstraat 11
Amsterdam, NL-1018WB
Netherlands

HOME PAGE: http://www1.fee.uva.nl/cendef/

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Sebastiano Manzan (Contact Author)

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States

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