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Macro-Financial Volatility under Dispersed Information

Author

Listed:
  • Jianjun Miao

    (Boston University)

  • Jieran Wu

    (Zhejiang University)

  • Eric Young

    (University of Virginia and Zhejiang University)

Abstract

We provide a production-based asset pricing model with dispersed information and small deviations from full rational expectations. In the log-linearized equilibrium system, aggregate output and equity prices depend on the higherorder beliefs about average forecasts of aggregate demand and individual stochastic discount factors, respectively. We prove that the presence of dispersed information reduces aggregate output volatility under very general information structures with strategic complementarity in production decisions. In contrast, equity price volatility becomes arbitrarily large as the volatility of the idiosyncratic shock approaches infinity due to the interaction of signal-extraction with idiosyncratic trading decisions. We show our analytical results using the frequencydomain techniques. Our model matches output and equity volatilities observed in the data.

Suggested Citation

  • Jianjun Miao & Jieran Wu & Eric Young, 2016. "Macro-Financial Volatility under Dispersed Information," Boston University - Department of Economics - Working Papers Series WP2019-10, Boston University - Department of Economics, revised May 2019.
    • Handle: RePEc:bos:wpaper:wp2019-010
    as

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    File URL: http://people.bu.edu/miaoj/Macro_Financial_Revised_9.pdf
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    References listed on IDEAS

    as
    1. Kenneth Kasa & Todd B. Walker & Charles H. Whiteman, 2014. "Heterogeneous Beliefs and Tests of Present Value Models," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 81(3), pages 1137-1163.
    2. Rondina, Giacomo & Walker, Todd B., 2021. "Confounding dynamics," Journal of Economic Theory, Elsevier, vol. 196(C).
    3. Hansen, Lars Peter & Sargent, Thomas J., 1980. "Formulating and estimating dynamic linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 2(1), pages 7-46, May.
    4. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-417, June.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Han, Zhao & Tan, Fei & Wu, Jieran, 2022. "Analytic policy function iteration," Journal of Economic Theory, Elsevier, vol. 200(C).
    2. Jurado, Kyle, 2023. "Rational inattention in the frequency domain," Journal of Economic Theory, Elsevier, vol. 208(C).

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    More about this item

    Keywords

    Dispersed Information; Frequency Domain Analysis; Higherorder Beliefs; Asset Pricing; Business Cycle; Incomplete Markets;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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