Heterogeneous Beliefs, Risk and Learning in a Simple Asset Pricing Model

Trade among individuals occurs either because tastes (risk aversion)differ, endowments differ, or beliefs differ. Utilising the concept of`adaptively rational equilibrium' and a recent framework of Brock and Hommes[6, 7] this paper incorporates risk and learning schemes into a simplediscounted present value asset price model with heterogeneous beliefs. Agentshave different risk aversion coefficients and adapt their beliefs (aboutfuture returns) over time by choosing from different predictors orexpectations functions, based upon their past performance as measured byrealized profits. By using both bifurcation theory and numerical analysis, itis found that the dynamics of asset pricing is affected by the relative riskattitudes of different types of investors. It is also found that the externalnoise and learning schemes can significantly affect the dynamics. Comparedwith the findings of Brock and Hommes [7] on the dynamics caused by change ofthe intensity of choice to switch predictors, it is found that many of theirinsights are robust to the generalizations considered: however, the resultingdynamical behavior is considerably enriched and exhibits some significantdifferences.

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