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Micro Frictions, Asset Pricing, and Aggregate Implications

39 Pages Posted: 22 Nov 2010 Last revised: 26 Nov 2011

Jack Y Favilukis

University of British Columbia (UBC) - Division of Finance

Xiaoji Lin

Ohio State University (OSU) - Fisher College of Business

Date Written: Nov 27, 2011

Abstract

We study the implications of recent advances in the asset pricing literature on investment, and vice versa in a DSGE model with non-trivial heterogeneity in production units, lumpy investment, and long run productivity risk. We make three contributions. First, for aggregate asset pricing, investment frictions do not change the price of risk; in fact even a frictionless model can deliver a high price of risk. Second, the failure of production models in producing a high volatility of equity is likely due to failures in matching the joint dynamics of profit, wage, and dividend rather than to investment frictions. We provide an experiment to show a promising mechanism that is useful for future research in this area. Third, for aggregate investment, long run productivity risk can produce heteroscedasticity and history dependence in aggregate investment rate, providing an alternative to the Bachmann, Caballero, and Engel (2010) explanation of these phenomena.

Keywords: Micro Frictons, Asset Pricing, General Equilibrium

JEL Classification: E23, E44, G12

Suggested Citation

Favilukis, Jack Y and Lin, Xiaoji, Micro Frictions, Asset Pricing, and Aggregate Implications (Nov 27, 2011). Available at SSRN: https://ssrn.com/abstract=1712949 or http://dx.doi.org/10.2139/ssrn.1712949

Jack Y Favilukis

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Xiaoji Lin (Contact Author)

Ohio State University (OSU) - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

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