Boswijk, H., Hommes, C. and Manzan, S. (2007). Behavioral heterogeneity in stock prices Journal of Economic Dynamics and Control, 31(6):1938--1970.

We estimate a dynamic asset pricing model characterized by heterogeneous boundedly rational agents. The fundamental value of the risky asset is publicly available to all agents, but they have different beliefs about the persistence of deviations of stock prices from the fundamental benchmark. An evolutionary selection mechanism based on relative past profits governs the dynamics of the fractions and switching of agents between different beliefs or forecasting strategies. A strategy attracts more agents if it performed relatively well in the recent past compared to other strategies. We estimate the model to annual US stock price data from 1871 until 2003. The estimation results support the existence of two expectation regimes, and a bootstrap F-test rejects linearity in favor of our nonlinear two-type heterogeneous agent model. One regime can be characterized as a fundamentalists regime, because agents believe in mean-reversion of stock prices toward the benchmark fundamental value. The second regime can be characterized as a chartist, trend following regime because agents expect the deviations from the fundamental to trend. The fractions of agents using the fundamentalists and trend following forecasting rules show substantial time variation and switching between predictors. The model offers an explanation for the recent stock prices run-up. Before the 1990s the trend following regime was active only occasionally. However, in the late 1990s the trend following regime persisted and reenforced an extraordinary deviation of stock prices from the fundamentals. Recently, the activation of the mean-reversion regime has contributed to drive stock prices back closer to their fundamental valuation.