Dynamic Equilibrium Economies: A Framework for Comparing Models and Data

40 Pages Posted: 14 Jul 2000 Last revised: 25 Jun 2010

See all articles by Francis X. Diebold

Francis X. Diebold

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Lee E. Ohanian

University of California, Los Angeles (UCLA) - Department of Economics; National Bureau of Economic Research (NBER)

Jeremy Berkowitz

University of Houston - Department of Finance

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Date Written: February 1995

Abstract

Many recent theoretical papers have come under attack for modeling prices as Geometric Brownian Motion. This process can diverge over time, implying that firms facing this price process can earn infinite profits. We explore the significance of this attack and contrast investment under Geometric Brownian Motion with investment assuming mean reversion. While analytically more complex, mean reversion in many cases is a more plausible assumption, allowing for supply responses to increasing prices. We show a mean reversion process rather than Geometric Brownian Motion and provide an explanation for this result.

Suggested Citation

Diebold, Francis X. and Ohanian, Lee E. and Berkowitz, Jeremy, Dynamic Equilibrium Economies: A Framework for Comparing Models and Data (February 1995). NBER Working Paper No. t0174, Available at SSRN: https://ssrn.com/abstract=225084

Francis X. Diebold (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
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HOME PAGE: http://www.ssc.upenn.edu/~fdiebold/

National Bureau of Economic Research (NBER)

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Lee E. Ohanian

University of California, Los Angeles (UCLA) - Department of Economics ( email )

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United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Jeremy Berkowitz

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States

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