Investor experiences and financial market dynamics

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 overlapping gen- erations (OLG) model, where different cross-cohort experiences generate persistent het-erogeneity 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.