The Role of Learning for Asset Prices and Business Cycles

Abstract

I examine the implications of learning-based asset pricing in a model in which firms face credit constraints that depend partly on their market value. Agents learn about stock prices, but have conditionally model-consistent expectations otherwise. The model jointly matches key asset price and business cycle statistics, while the combination of financial frictions and learning produces powerful feedback between asset prices and real activity, adding substantial amplification. The model reproduces many patterns of forecast error predictability in survey data that are inconsistent with rational expectations. A reaction of the monetary policy rule to asset price growth increases welfare under learning.