Adaptive Beliefs and the Emergence of Complex Dynamics in Asset Pricing Models

William A. Brock
Department of Economics and Social Research Institute, University of Wisconsin
Brock@macc.wisc.edu

Cars H. Hommes
Department of Economics and Tinbergen Institute, University of Amsterdam
Hommes@fee.uva.nl

Abstract

Evolutionary dynamics in a simple present value asset pricing model with heterogeneous expectations among agents is introduced. Agents revise their ``beliefs" concerning future prices of a risky asset in each period in a rational way, according to a ``fitness measure" such as a weighted sum of past realized profits. Price fluctuations are thus driven by an evolutionary dynamics between different expectations schemes (``rational animal spirits"). We investigate whether this evolutionary dynamics can match some stylized facts observed in financial markets.