Investor Experiences and Financial Market Dynamics

TL;DR

This paper develops an overlapping generations model incorporating experience-based learning to explain how macro-financial shocks influence investor beliefs, market dynamics, and heterogeneity across age groups, aligning with observed asset price features.

Contribution

It introduces a novel OLG model linking demographic experience effects to persistent belief heterogeneity and market outcomes, including asset prices and trading behavior.

Findings

Model reproduces excess volatility and return predictability.

Explains cross-cohort differences in investment responses.

Aligns with empirical data on asset holdings and trade volume.

Abstract

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.