How do financial crises and stock-market fluctuations affect investor behavior and the dynamicsof financial markets in the long run ? Recent evidence suggests that individuals overweight personal experiences of macroeconomic shocks when forming beliefs and making investmentdecisions. We propose a theoretical foundation for such experience-based learning and derive its dynamic implications in a simple OLG model. Risk averse agents invest in a risky and a risk-free asset. They form beliefsabout the payoff of the risky asset based on the two key components of experience effects: (1) they overweight data observed during their lifetimes so far, and (2) they exhibit recency bias. In equilibrium, prices depend on past dividends, but only on those observed by the generations that are alive, and they are more sensitive to more recent dividends. Younger generations react more strongly to recent experiences than older generations, and hence have higher demand for the risky asset in good times, but lower demand in bad times. As a result, a crisis increases the average age of stock market participants, while booms have the opposite effect. The stronger the disagreement across generations (e.g., after a recent shock), the higher is the trade volume. We also show that, vice versa, the demographic composition of markets significantly influences the response to aggregate shocks. We generate empirical results on stock-market participation, stock-market investment, and trade volume from theSurvey of Consumer Finances , merged with CRSP and historical data on stock-market performance, that are consistent with the model predictions .
How do macro-financial shocks affect investor behavior and market dynamics ? Recent evidence on experience effects suggests a long-lasting influence of personally experienced outcomes on investor beliefs and investment, but also significant differences across older and younger generations. We formalize experience-based learning in an OLG model, where different cross-cohort experiences generate persistent heterogeneity in beliefs, portfolio choices, and trade. The model allows us to characterize a novel link between investor demographics and the dependence of prices on past dividends, while also generating known features of asset prices, such as excess volatility and return predictability. The model produces new implications for the cross-section of asset holdings, trade volume, and investors' heterogenous responses to recent financial crises, which we show to be in line with the data .
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financial crises and stock-market fluctuations
macro-financial shocks
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the dynamicsof financial markets in the long run
market dynamics
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suggests that individuals overweight personal experiences of macroeconomic shocks when forming beliefs and making investmentdecisions. We propose a theoretical foundation for such
on experience effects suggests a long-lasting influence of personally experienced outcomes on investor beliefs and investment, but also significant differences across older and younger generations. We formalize
R
and derive its dynamic implications in a simple OLG model. Risk averse agents invest in a risky and a risk-free asset. They form beliefsabout the payoff of the risky asset based on the two key components of experience effects: (1) they overweight data observed during their lifetimes so far, and (2) they exhibit recency bias. In equilibrium, prices depend
in an OLG model, where different cross-cohort experiences generate persistent heterogeneity in beliefs, portfolio choices, and trade. The model allows us to characterize a novel link between investor demographics and the dependence of prices
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but only on those observed by the generations that are alive, and they are more sensitive to more recent dividends. Younger generations react more strongly to recent experiences than older generations, and hence have higher demand for the risky asset in good times, but lower demand in bad times. As a result, a crisis increases the average age of stock market participants, while booms have the opposite effect. The stronger the disagreement across generations (e.g., after a recent shock), the higher is the trade volume. We also show that, vice versa, the demographic composition of markets significantly influences the response to aggregate shocks. We generate empirical results on stock-market participation, stock-market investment, and trade volume from the
D
Survey of Consumer Finances
R
, merged with CRSP and historical data on stock-market performance, that are consistent with the model predictions
while also generating known features of asset prices, such as excess volatility and return predictability. The model produces new implications for the cross-section of asset holdings, trade volume, and investors' heterogenous responses to recent financial crises, which we show to be in line with the data