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Working Paper
The Inherent Nonlinearity in Learning: Implications for Understanding Stock Returns
Financial markets (and more generally the real economy) display a wide range of important nonlinearities. This paper focuses on stock returns, which are skewed left– generating crashes– and have volatility that moves over time, is itself skewed, is strongly related to the level of prices, and displays long memory. This paper shows that such behavior is actually almost inevitable when prices are formed by investors acquiring information about the true, but latent, value of stocks. It studies a general model of filtering in which agents receive signals about the fundamental value of the ...