Endogenous Rational Bubbles

Tests on simulated data from an asset pricing model with heterogeneous forecasts show excess variance in the price and ARCH effects in the returns, features not explained by the strong version of the efficient markets hypothesis. An evolutionary game theory dynamic describes how agents switch between a fundamental forecast, a rational bubble forecast and the reflective forecast, which is a weighted average of the former two. Conditions determining the frequency and duration of episodes where a significant fraction of agents adopt the rational bubble forecast leading to large deviations in the price-dividend ratio are discussed.