Information Aggregation in a DSGE Model

49 Pages Posted: 25 Sep 2014

See all articles by Tarek A. Hassan

Tarek A. Hassan

Boston University; 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: June 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: Asset Prices, Business Cycles, Dispersed Information, Investment, Noisy Rational Expectations, Portfolio Choice

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

Suggested Citation

Hassan, Tarek Alexander and Mertens, Thomas M., Information Aggregation in a DSGE Model (June 2014). CEPR Discussion Paper No. DP10020, Available at SSRN: https://ssrn.com/abstract=2501492

Tarek Alexander Hassan (Contact Author)

Boston University ( email )

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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 )

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