Feedback Effect and Excess Volatility with Learning

Abstract

We set out in this study to analyze learning with regard to both fundamentals and observations on asset prices and aggregate investment, explicitly linking this to the dual endogeneity in an investment model, and then discussing the effects of both feedback and coordination incentives on excess volatility and certain investment phenomena. A notable finding is that, regardless of whether or not learning is evident, the coordination incentives amongst agents may well result from the feedback effect; indeed, the stronger the effect of feedback, the higher the coordination incentives. Alternatively, with high liquidity in the financial market, or with the occurrence of substantial shocks, the coordination incentives amongst agents are found to decline under learning, whereas under no learning, they are fixed. Although there is an increase in excess asset price volatility with both the feedback effect and coordination incentives, there is a decrease with the mass of investing firms. At the same time, learning relating to prices is found to amplify the excess asset price volatility more than no learning, whilst learning relating to aggregate investment also increases the excess asset price volatility more than no learning.