Prices, fundamental values and learning

In this paper we show how uncertainty and learning about fundamental values can lead to excess volatility in prices and to volatility clustering in returns, as observed on real markets. The key assumption is that agents use prices, besides an exogenous signal on long run dividends, to infer fundamental values: as the relative weight on the two signals changes endogenously through learning, price dynamics are a¤ected. In particular, periods of high volatility are periods where agents rely more heavily on prices in predicting fundamentals.