Creator: Ostroy, Joseph M. and Potter, Simon M. Series: Finance, fluctuations, and development Abstract:
We formulate a representative consumer model of intertemporal resource reallocation in which fluctuations in equity prices contribute to the smoothing of consumption flows. Features of the model include (a) an incompletely observable stochastic process of productivity shocks leading to fluctuating confidence of beliefs and (b) technologies involving commitments of a resource good. These features are exploited to show that (1) equities are not a representative form of total wealth and (2) the valuation of currently active firms is not representative of the valuation of all firms. We examine the implications of (1) and (2) to argue that empirical findings for the volatility and 'value shortfall' of equity prices may be consistent with a frictionless representative consumer model having a low degree of risk-aversion. Simulation of a calibrated version of the model for a risk-neutral consumer shows that when the 'data' is analyzed according to current econometric procedures, it is found to exhibit volatility of the same order of magnitude as that found in the actual data, although the model contains no excess volatility.
Keyword: Technological commitments, Equity premium, Uncertainty of beliefs, Excess volatility, and Value shortfall Subject (JEL): G12 - General financial markets - Asset pricing ; Trading volume ; Bond interest rates, E44 - Money and interest rates - Financial markets and the macroeconomy, G14 - General financial markets - Information and market efficiency ; Event studies, and E13 - General aggregative models - Neoclassical
Creator: Jackson, Matthew O. and Peck, James. Series: Finance, fluctuations, and development Abstract:
We examine price formation in a simple static model with asymmetric information, a countable number of risk neutral traders and without noise traders. Prices can exhibit excess volatility (the variance of prices exceeds the variance of dividends), even in such a simple model. More generally, we show that for an open set of parameter values no equilibrium has prices which turn out to equal the value of dividends state by state, while for another open set of parameter values there exist equilibria such that equilibrium prices equal the value of dividends state by state. When information collection is endogenous and costly, expected prices exhibit a "V-shape" as a function of the cost of information: They are maximized when information is either costless so that everyone acquires it, or else is so costly that no one chooses to acquire it. Prices are depressed if information is cheap enough so that some agents become informed, while others do not. If the model is altered so that information is useful in making productive decisions, then the V-shape is altered, reducing the attractiveness of prohibitively high costs.
Subject (JEL): G14 - General financial markets - Information and market efficiency ; Event studies, D50 - General equilibrium and disequilibrium - General, and C70 - Game theory and bargaining theory - General