Abstract
We provide a production‐based asset pricing model with dispersed information and small deviations from full rational expectations. In the model, aggregate output and equity prices depend on the higher‐order beliefs about aggregate demand and individual stochastic discount factors. We prove that equity price volatility becomes arbitrarily large as the volatility of idiosyncratic shocks diverges to infinity due to the interaction of signal extraction with idiosyncratic trading decisions, while aggregate output volatility falls. We propose a two‐step spectral factorization method that permits closed‐form solutions in the frequency domain applicable to a wide range of models with more hidden states than signals. Our model can quantitatively match output and equity volatilities observed in U.S. data.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
