Asset Pricing With Incomplete Information and Fat Tails
Journal of Economic Dynamics and Control, Volume 33, Issue 6, June 2009, Pages 1314-1331
47 Pages Posted: 23 May 2019
Date Written: March 23, 2009
We study a consumption-based asset pricing model with incomplete information and a- stable shocks. Incomplete information leads to a non-Gaussian filtering problem. Bayesian updating generates fluctuating confidence in the agents’ estimate of the persistent component of the dividends’ growth rate. This has the potential to generate time variation in the volatility of model-implied returns, without relying on discrete shifts in the drift rate of dividend growth rates. A test of the model using US consumption data shows that implied returns display significant volatility persistence of a magnitude comparable to that in the data.
Keywords: Asset pricing, Incomplete information, Time-varying volatility, Fat tails, Stable distributions
JEL Classification: G12, G13, E43
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