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Asset pricing with incomplete information and fat tails

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  • Bidarkota, Prasad V.
  • Dupoyet, Brice V.
  • McCulloch, J. Huston

Abstract

We study a consumption-based asset pricing model with incomplete information and [alpha]-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.

Suggested Citation

  • Bidarkota, Prasad V. & Dupoyet, Brice V. & McCulloch, J. Huston, 2009. "Asset pricing with incomplete information and fat tails," Journal of Economic Dynamics and Control, Elsevier, vol. 33(6), pages 1314-1331, June.
    • Handle: RePEc:eee:dyncon:v:33:y:2009:i:6:p:1314-1331
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    2. Zimper, Alexander, 2012. "Asset pricing in a Lucas fruit-tree economy with the best and worst in mind," Journal of Economic Dynamics and Control, Elsevier, vol. 36(4), pages 610-628.
    3. Marcin Pitera & Aleksei Chechkin & Agnieszka Wyłomańska, 2022. "Goodness-of-fit test for $$\alpha$$ α -stable distribution based on the quantile conditional variance statistics," Statistical Methods & Applications, Springer;Società Italiana di Statistica, vol. 31(2), pages 387-424, June.
    4. Aknouche, Abdelhakim & Al-Eid, Eid & Demouche, Nacer, 2016. "Generalized quasi-maximum likelihood inference for periodic conditionally heteroskedastic models," MPRA Paper 75770, University Library of Munich, Germany, revised 19 Dec 2016.
    5. Ñíguez, Trino-Manuel & Paya, Ivan & Peel, David & Perote, Javier, 2012. "On the stability of the constant relative risk aversion (CRRA) utility under high degrees of uncertainty," Economics Letters, Elsevier, vol. 115(2), pages 244-248.
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    7. T M Niguez & I Paya & D Peel & J Perote, 2011. "On the stability of the CRRA utility under high degrees of uncertainty," Working Papers 615773, Lancaster University Management School, Economics Department.
    8. Faisal M. Awwal & Prasad V. Bidarkota, 2021. "A state space framework for the residual income valuation model of stock prices," SN Business & Economics, Springer, vol. 1(4), pages 1-28, April.
    9. Garcia, René & Renault, Eric & Veredas, David, 2011. "Estimation of stable distributions by indirect inference," Journal of Econometrics, Elsevier, vol. 161(2), pages 325-337, April.
    10. Abdelhakim Aknouche & Eid Al-Eid & Nacer Demouche, 2018. "Generalized quasi-maximum likelihood inference for periodic conditionally heteroskedastic models," Statistical Inference for Stochastic Processes, Springer, vol. 21(3), pages 485-511, October.
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