DP13973 Asset Pricing with Fading Memory

Author(s): Stefan Nagel, Zhengyang Xu
Publication Date: August 2019
Date Revised: September 2019
Programme Areas: Financial Economics, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13973

Building on evidence that lifetime experiences shape individuals' macroeconomic expectations, we study asset prices in an economy in which a representative agent learns with fading memory about unconditional mean endowment growth. With IID fundamentals, constant risk aversion, and memory decay calibrated to microdata, the model generates a high and strongly counter-cyclical objective equity premium, while the subjective equity premium is virtually constant. Consistent with this theory, experienced payout growth (a weighted average of past growth rates) is negatively related to future stock market excess returns and subjective expectations errors in surveys, and positively to analyst forecasts of long-run earnings growth.