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Regime Shifts and Changing Volatility in Stock Returns: A Rational Expectations Equilibrium Model

Center for Research in Security Prices Working Paper No. 474

49 Pages Posted: 11 Sep 1998  

Pietro Veronesi

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

Date Written: May 1998

Abstract

I present an intertemporal asset pricing model of learning to explain the GARCH behavior of stock returns and the intertemporal variation of expected returns. I assume that dividends follow a diffusion process whose drift rate shifts between two unobservable states at random times. I first show that the asset price is increasing and convex in investors' posterior probability of the good state. I then characterize the changes in asset price sensitivity to news, return volatility and expected returns as function of investors' level of uncertainty over the state of the economy.

JEL Classification: G12, G13, G14

Suggested Citation

Veronesi, Pietro, Regime Shifts and Changing Volatility in Stock Returns: A Rational Expectations Equilibrium Model (May 1998). Center for Research in Security Prices Working Paper No. 474. Available at SSRN: https://ssrn.com/abstract=120630 or http://dx.doi.org/10.2139/ssrn.120630

Pietro Veronesi (Contact Author)

University of Chicago - Booth School of Business ( email )

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Centre for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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