Information Aggregation in a DSGE Model

46 Pages Posted: 22 Mar 2014 Last revised: 26 Jun 2016

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

Federal Reserve Bank of San Francisco

Multiple version iconThere are 3 versions of this paper

Date Written: May 28, 2014

Abstract

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.

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

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

Suggested Citation

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

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 )

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Centre for Economic Policy Research (CEPR) ( email )

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Thomas M. Mertens

Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

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