Rational Speculators, Contrarians and Excess Volatility

The VAR approach for testing present value models is applied to a nonlinear asset pricing model with three types of agents, using historical US stock prices and dividends. Besides rational long-term investors, that value assets according to expected dividends, the model includes rational and contrarian speculators. Agents choose their regime based on evolutionary considerations. Supplementing the standard present value model with speculative agents dramatically improves the model's ability to replicate the observed market dynamics. In particular the existence of contrarians can explain some of the most volatile episodes including the 1990s bubble, suggesting this was not a rational bubble.