Predicting excess returns under heterogeneous trading and learning: A diffusive approach

This paper combines the effects on asset price dynamics of two groups of traders: feedback traders who mechanically respond to price changes and bounded rationality traders who learn from lagged values of prices and dividends. First, we find that in the weak limit, as the trade interval goes to zero, the asset price is described by a mean reverting process around the level given by the forecasted price. Second, we show how feedback trading and learning effects on asset price dynamics may explain the empirical finding of long run dependencies on dividend yields in financial time series.