Asset Pricing Bubble Formation with Heterogenous Agents

In this paper we study the accruement and decay of asset pricing bubbles under the assumption that young agents behave boundedly rational when rst entering the market and then gain more and more experience when growing older, nally reaching a state of perfect rational behavior. Therefore we set up an overlapping generations model where agents form their beliefs about the payo of a risky asset by compiling a rational signal element and an irrational momentum component. Young generations of traders are unexperienced in fundamental signal interpretation and thus put high weight on momentum observation whereas old generations overweight the signal term when making their decisions. We show that bubbles can arise and de ate endogenously in this setting when a signal arrives, and that experienced traders can make pro t in the market whereas unexperienced traders will loose money. Overall lifetime performance is dependent on the phase that the market is in when a trader rst enters it. Also we analyze exploiting behavior of experienced traders and show that after a shock they tend to push prices beyond the myopic optimum to induce strong momentum in the following period when optimizing their intertemporal utility in a dynamic way. JEL-Classi cation: G12, D83