Hostname: page-component-cd9895bd7-fscjk Total loading time: 0 Render date: 2024-12-28T00:51:22.320Z Has data issue: false hasContentIssue false
  • English
  • Français

ENDOGENOUS PARTICIPATION, RISK, AND LEARNING IN THE STOCK MARKET

Published online by Cambridge University Press:  06 August 2020

Michael Shin
Michael Shin*
Affiliation:
The University of Sydney
*
Address correspondence to: Michael Shin, The University of Sydney Business School, Rm 539 Lvl 5 Codrington Building H69, The University of Sydney, Sydney, NSW, Australia 2006. e-mail: michael.shin@sydney.edu.au. Phone: +61 4 6627 1247.
Get access Rights & Permissions [Opens in a new window]

Abstract

A simple asset pricing model with both endogenous stock market participation and subjective risk can explain the negative cross-country correlation between participation rates and the volatility of excess returns, along with the time-varying participation rates in the data. Belief-driven learning dynamics can explain the interplay between participation rates, subjective risk, and stock price volatility. When agents adaptively learn about the risk and return, my model generates 25% of the excess volatility observed in US stock prices, while also matching key moments. With learning about risk, excess volatility of stock prices is driven by fluctuations in the participation rate that arise because agents’ risk estimates vary with prices. I find that learning about risk is quantitatively more important than learning about returns.

Keywords

Stock Market ParticipationAdaptive LearningExcess VolatilityAsset Pricing
Type
Articles
Information
Macroeconomic Dynamics , Volume 26 , Issue 3 , April 2022 , pp. 649 - 681
Copyright
© Cambridge University Press 2020

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

Discipline of Finance, The University of Sydney. I am deeply indebted to Bill Branch for his extensive input on this paper. I would also like to thank John Duffy, David Hirshleifer, Chong Huang, Fabio Milani, Guillaume Rocheteau, Eric Swanson, Pat Testa, participants at the SNDE Symposium and two anonymous referees for their valuable feedback. All errors are my own.

References

REFERENCES

Adam, K., Marcet, A. and Nicolini, J. P. (2016) Stock market volatility and learning. The Journal of Finance 71(1), 33–82.CrossRefGoogle Scholar
Allen, F. and Gale, D. (1994) Limited market participation and volatility of asset prices. The American Economic Review 84(4), 933–955.Google Scholar
Ameriks, J., Kezdi, G., Lee, M. and Shapiro, M. D. (2019) Heterogeneity in expectations, risk tolerance, and household stock shares: The attenuation puzzle. Journal of Business and Economic Statistics, 1–14.Google ScholarPubMed
Arrondel, L., Calvo-Pardo, H. F. and Tas, D. (2014) Subjective return expectations, information and stock market participation: Evidence from France. Working Paper.CrossRefGoogle Scholar
Babcock, B. A., Kwan Choi, E. and Feinerman, E. (1993) Risk and probability premiums for CARA utility functions. Journal of Agricultural and Resource Economics 18(1), 17–24.Google Scholar
Baker, M. and Wurgler, J. (2000) The equity share in new issues and aggregate stock returns. The Journal of Finance 55(5), 2219–2257.CrossRefGoogle Scholar
Branch, W. A. and Evans, G. W. (2006) A simple recursive forecasting model. Economic Letters 91, 158–166.CrossRefGoogle Scholar
Branch, W. A. and Evans, G. W. (2011) Learning about risk and return: A simple model of bubbles and crashes. American Economic Journal: Macroeconomics 3(3), 159–191.Google Scholar
Branch, W. A. and Evans, G. W. (2013) Bubbles, crashes and risk. Economic Letters 120, 254–258.CrossRefGoogle Scholar
Buffie, E. F. and Zanna, L.-F. (2017) Limited asset market participation and determinacy in the open economy. Macroeconomic Dynamics 22(8), 1–41.Google Scholar
Bullard, J. and Duffy, J. (2001) Learning and excess volatility. Macroeconomic Dynamics 5(2), 272–302.CrossRefGoogle Scholar
Campbell, J. Y. (2006) Household finance. The Journal of Finance 61(4), 1553–1604.CrossRefGoogle Scholar
Campbell, J. Y. (2018) Financial Decisions and Markets. Princeton, NJ: Princeton University Press.Google Scholar
Dimson, E., Marsh, P. and Staunton, M. (2002) Triumph of the Optimists. Princeton, NJ: Princeton University Press.CrossRefGoogle Scholar
Evans, G. W. and Honkapohja, S. (1995) Local convergence of recursive learning to steady states and cycles in stochastic nonlinear models. Econometrica 63(1), 195–206.CrossRefGoogle Scholar
Evans, G. W. and Honkapohja, S. (2001) Learning and Expectations in Macroeconomics. Princeton, NJ: Princeton University Press.CrossRefGoogle Scholar
Evans, G. W., Honkapohja, S. and Williams, N. (2010) Generalized stochastic gradient learning. International Economic Review 51(1), 237–262.CrossRefGoogle Scholar
Fagereng, A., Gottlieb, C. and Guiso, L. (2017) Asset market participation and portfolio choice over the life-cycle. The Journal of Finance 72(2), 705–750.CrossRefGoogle Scholar
Gomes, F. and Michaelides, A. (2005) Optimal life-cycle asset allocation: Understanding the empirical evidence. The Journal of Finance 60(2), 869–904.CrossRefGoogle Scholar
Greenwood, R. and Shleifer, A. (2014) Expectations of returns and expected returns. The Review of Financial Studies 27(3), 714–746.CrossRefGoogle Scholar
Guiso, L., Haliassos, M. and Jappelli, T. (ed.) (2002) Household Portfolios. Cambridge, MA: MIT Press.CrossRefGoogle Scholar
Guiso, L., Sapienza, P. and Zingales, L. (2008) Trusting the stock market. The Journal of Finance 63(6), 2557–2600.CrossRefGoogle Scholar
Guiso, L. and Sodini, P. (2013) Household finance: An emerging field. In: Constantinides, G. M., Harris, M. and Stulz, R. M. (eds.), The Handbook of the Economics of Finance, Volume 2, Part B, pp. 1397–1532.Google Scholar
Guo, H. (2004) Limited stock market participation and asset prices in a dynamic economy. Journal of Financial and Quantitative Analysis 39(3), 495–516.CrossRefGoogle Scholar
Guvenen, F. (2009) A parsimonious macroeconomic model for asset pricing. Econometrica 77(6), 1711–1750.Google Scholar
Lansing, K. J. (2015) Asset pricing with concentrated ownership of capital and distribution shocks. American Economic Journal: Macroeconomics 7(4), 67–103.Google Scholar
Ljungqvist, L. and Sargent, T. J. (2011) A labor supply elasticity accord? American Economic Review 101(3), 487–491.CrossRefGoogle Scholar
Lucas, R. E. (1978) Asset prices in an exchange economy. Econometrica 46(6), 1429–1445.CrossRefGoogle Scholar
Malmendier, U. and Nagel, S. (2011) Depression babies: Do macroeconomic experiences affect risk-taking? The Quarterly Journal of Economics 126(1), 373–416.CrossRefGoogle Scholar
Mankiw, N. G. and Zeldes, S. P. (1991) The consumption of stockholders and nonstockholders. Journal of Financial Economics 29(1), 97–112.CrossRefGoogle Scholar
Marcet, A. and Sargent, T. J. (1989) Convergence of least squares learning mechanisms in self-referential linear stochastic models. Journal of Economic Theory 48(2), 337–368.CrossRefGoogle Scholar
Milani, F. (2007) Expectations, learning, and macroeconomic persistence. Journal of Monetary Economics 54(7), 2065–2082.CrossRefGoogle Scholar
Nakov, A. and Nuño, G. (2015) Learning from experience in the stock market. Journal of Economic Dynamics and Control 52, 224–239.CrossRefGoogle Scholar
Orosel, G. O. (1998) Participation costs, trend chasing, and volatility of stock prices. The Review of Financial Studies 11(3), 521–557.CrossRefGoogle Scholar
Rogerson, R. (1988) Indivisible labor, lotteries, and equilibrium. Journal of Monetary Economics 21(1), 3–16.CrossRefGoogle Scholar
Sargent, T. J. (1993) Bounded Rationality in Macroeconomics. Oxford, UK: Oxford University Press.Google Scholar
Timmermann, A. G. (1993) How learning in financial markets generates excess volatility and predictability in stock prices. The Quarterly Journal of Economics 108(4), 1135–1145.CrossRefGoogle Scholar
Vissing-Jørgensen, A. (2002) Limited asset market participation and the elasticity of intertemporal substitution. Journal of Political Economy 110(4), 825–853.CrossRefGoogle Scholar
Xing, X. (2004) Why does stock market volatility differ across countries? Evidence from thirty-seven international markets. International Journal of Business 9(1), 83–102.Google Scholar