Asset Pricing with Incomplete Information under Stable Shocks
Prasad V. Bidarkota
Florida International University (FIU) - Department of Economics
Brice V. Dupoyet
Florida International University - College of Business Administration - Finance
J. Huston Mcculloch
Ohio State University; National Bureau of Economic Research (NBER)
September 1, 2005
We study a consumption based asset pricing model with incomplete information and alpha-stable shocks. Incomplete information leads to a non-Gaussian filtering problem. Bayesian updating generates fluctuating confidence in the agents' estimate of the persistent component of the dividends' growth rate. Similar results are obtained with alternate distributions exhibiting fat tails (Extreme Value distribution, Pearson Type IV distribution) while they are not with a thin-tail distribution (Binomial distribution). This has the potential to generate time variation in the volatility of model-implied returns, without relying on discrete shifts in the drift rate of dividend growth rates. A test of the model using US consumption data indicates strong support in the sense that the implied returns display significant volatility persistence of a magnitude comparable to that in the data.
Number of Pages in PDF File: 68
Keywords: asset pricing, incomplete information, time-varying volatility, fat tails, stable distributions
JEL Classification: G12, G13, E43working papers series
Date posted: November 8, 2005
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