Disagreement, Speculation, and Aggregate Investment
41 Pages Posted: 2 Nov 2013 Last revised: 18 Aug 2016
Date Written: March 21, 2015
Abstract
When investors disagree, speculation between them alters equilibrium prices in financial markets. Because managers maximize firm value given financial market prices, disagreement alters firms’ value-maximizing investment policies. Disagreement therefore impacts aggregate investment, consumption, and output. In a production economy with recursive preferences and disasters, we demonstrate that static disagreement among investors generates dynamic aggregate investment that is positively correlated with shocks, leading to stochastic volatility in aggregate consumption, investment and equity returns. The direction of these effects is consistent with business cycle facts, and with several features of the 2008 financial crisis.
Keywords: speculation, aggregate investment, heterogeneous beliefs, disasters, recursive preferences
JEL Classification: E22, E44, G12
Suggested Citation: Suggested Citation