Endogenous Participation, Risk, and Learning in the Stock Market

A simple asset pricing model with endogenous participation and subjective risk can explain both the negative cross-country correlation between participation rates and the volatility of excess returns along with the time-varying participation rates in the data. Belief-driven learning dynamics are key to explaining the interplay between participation, subjective risk, and price volatility. When agents adaptively learn about the risk and return, the model can generate 25% of the excess volatility in stock prices observed in U.S. data while matching key moments. With learning about risk, excess volatility of prices is driven by fluctuations in the participation rate that arise because agents' risk estimates vary with prices. I find that learning about risk is quantitatively more important than learning about returns