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Asset Pricing with Incomplete Information under Stable Shocks

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Author Info
Prasad V. Bidarkota () (Department of Economics, Florida International University)
Brice V. Dupoyet () (Department of Finance, Florida International University)
J. Huston McCulloch () (Department of Economics, Ohio State University)

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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. Similar results are obtained with alternate distributions exhibiting fat tails (Extreme Value distribution, Pearson Type IV distribution) while they are not with a thin-tail distribution (Binomial distribution). 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 indicates strong support in the sense that the implied returns display significant volatility persistence of a magnitude comparable to that in the data.

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File URL: http://www.fiu.edu/orgs/economics/wp2005/05-14.pdf
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Publisher Info
Paper provided by Florida International University, Department of Economics in its series Working Papers with number 0514.

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Length: 68 pages
Date of creation: Sep 2005
Date of revision:
Handle: RePEc:fiu:wpaper:0514

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Related research
Keywords: asset pricing; incomplete information; time-varying volatility; fat tails; stable distributions;

Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates

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References listed on IDEAS
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Zhiguang Wang & Prasad V. Bidarkota, 2008. "A Long-Run Risks Model of Asset Pricing with Fat Tails," Working Papers 0810, Florida International University, Department of Economics. [Downloadable!]
  2. GARCIA, RenŽ & RENAULT, Eric & VEREDAS, David, 2006. "Estimation of stable distributions by indirect inference," CORE Discussion Papers 2006112, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE). [Downloadable!]
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