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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: [email protected]. Phone: +61 4 6627 1247.
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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

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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.

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