Asset Pricing with Disagreement and Uncertainty about the Length of Business Cycles
50 Pages Posted: 20 Sep 2017 Last revised: 7 Aug 2020
Date Written: July 24, 2017
We study an economy with incomplete information in which two agents are uncertain and disagree about the length of business cycles. That is, the agents do not question whether the economy is growing or not, but instead continuously estimate how long economic cycles will last — i.e., they learn about the persistence of fundamentals. Learning about persistence generates high and persistent stock return volatility mostly during recessions, but also (to a smaller extent) during economic booms. Disagreement among agents fluctuates and earns a risk premium. A clear risk-return tradeoff appears only when conditioning on the sign and magnitude of disagreement. We confirm these predictions empirically.
Keywords: Learning, Uncertainty, Disagreement, Volatility, Risk Premium
JEL Classification: D51, D83, G12, G14
Suggested Citation: Suggested Citation