Information Aggregation in a DSGE Model

Tarek A. Hassan

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Thomas M. Mertens

New York University (NYU) - Department of Finance

May 28, 2014

We introduce the information microstructure of a canonical noisy rational expectations model (Hellwig, 1980) into the framework of a conventional real business cycle model. Each household receives a private signal about future productivity. In equilibrium, the stock price serves to aggregate and transmit this information. We find that dispersed information about future productivity affects the quantitative properties of our real business cycle model in three dimensions. First, households' ability to learn about the future affects their consumption-savings decision. The equity premium falls and the risk-free interest rate rises when the stock price perfectly reveals innovations to future productivity. Second, when noise trader demand shocks limit the stock market's capacity to aggregate information, households hold heterogeneous expectations in equilibrium. However, for a reasonable size of noise trader demand shocks the model cannot generate the kind of disagreement observed in the data. Third, even moderate heterogeneity in the equilibrium expectations held by households has a sizable effect on the level of all economic aggregates and on the correlations and standard deviations produced by the model. For example, the correlation between consumption and investment growth is 0.29 when households have no information about the future, but 0.41 when information is dispersed.

Number of Pages in PDF File: 46

Keywords: Noisy Rational Expectations, Dispersed Information, Business Cycles, Asset Prices, Investment, Portfolio Choice

JEL Classification: C63, D83, E2, E3, E44, G11

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Date posted: March 22, 2014 ; Last revised: May 29, 2014

Suggested Citation

Hassan, Tarek A. and Mertens, Thomas M., Information Aggregation in a DSGE Model (May 28, 2014). Available at SSRN: http://ssrn.com/abstract=2412270 or http://dx.doi.org/10.2139/ssrn.2412270

Contact Information

Tarek Alexander Hassan (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
HOME PAGE: http://faculty.chicagobooth.edu/tarek.hassan/index.html
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Centre for Economic Policy Research (CEPR) ( email )
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Thomas M. Mertens
New York University (NYU) - Department of Finance ( email )
Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
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