Behavioral Heterogeneity in Stock Prices
Tinbergen Discussion Paper No. TI 05-05/21
37 Pages Posted: 3 Mar 2005
There are 2 versions of this paper
Behavioral Heterogeneity in Stock Prices
Date Written: May 2005
Abstract
We estimate a behavioral 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 past profits determines the dynamics of the fractions and switching of agents between different 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. One regime can be characterized as a bubble regime because agents expect the deviations from the fundamental to trend; the second regime is characterized by beliefs of mean reversion toward the benchmark value. The fraction of agents using the predictors shows substantial time variation and switching between predictors. The model offers an explanation for the recent stock prices run-up. Before the 90s, the bubble regime was active only occasionally. However, in the late 90s, the bubble regime persisted and created an extraordinary deviation of stock prices from the fundamentals. Recently, the activation of the mean reverting regime has contributed to drive the price back toward the fundamental valuation.
Keywords: Asset pricing, behavioral finance, bounded rationality
JEL Classification: G12, G14
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
Recommended Papers
-
Coordination of Expectations in Asset Pricing Experiments
By Cars H. Hommes, Joep Sonnemans, ...
-
Behavioral Heterogeneity in Stock Prices
By H. Peter Boswijk, Cars H. Hommes, ...
-
Heterogeneity, Market Mechanisms, and Asset Price Dynamics
By Carl Chiarella, Roberto Dieci, ...
-
Complex Evolutionary Systems in Behavioral Finance
By Cars H. Hommes and Florian Wagener
-
More Hedging Instruments May Destabilize Markets
By William A. Brock, Cars H. Hommes, ...
-
By Anke Gerber, Bodo Vogt, ...
-
Indirect Estimation of the Parameters of Agent Based Models of Financial Markets
By Manfred Gilli and Peter Winker