Heterogeneous beliefs, risk and learning in a simple asset pricing model

Trade among individuals occurs either because tastes (risk aversion) differ, endowmentsdiffer, or beliefs differ. Utilising the concept of 'adaptively rational equilibrium' and a recent frameworkof Brock and Hommes [6, 7] this paper incorporates risk and learning schemes into a simplediscounted present value asset price model with heterogeneous beliefs. Agents have different riskaversion coefficients and adapt their beliefs (about future returns) over time by choosing from differentpredictors or expectations functions, based upon their past performance as measured by realizedprofits. By using both bifurcation theory and numerical analysis, it is found that the dynamics of assetpricing is affected by the relative risk attitudes of different types of investors. It is also found thatthe external noise and learning schemes can significantly affect the dynamics. Compared with thefindings of Brock and Hommes [7] on the dynamics caused by change of the intensity of choice toswitch predictors, it is found that many of their insights are robust to the generalizations considered:however, the resulting dynamical behavior is considerably enriched and exhibits some significantdifferences.