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Asset Pricing with Incomplete Information In a Discrete Time Pure Exchange Economy

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  • Prasad Bidarkota

    ()
    (Department of Economics, Florida International University)

  • Brice Dupoyet

    ()
    (Department of Finance, Florida International University)

Abstract

We study the consumption based asset pricing model in a discrete time pure exchange setting with incomplete information. Incomplete information leads to a filtering problem which agents solve using the Kalman filter. We characterize the solution to the asset pricing problem in such a setting. Empirical estimation with US consumption data indicates strong statistical support for the incomplete information model versus the benchmark complete information model. We investigate the ability of the model to replicate some key stylized facts about US equity and riskfree returns.

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File URL: http://casgroup.fiu.edu/pages/docs/2244/1275229961_06-03.pdf
File Function: First version, 2006
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Bibliographic Info

Paper provided by Florida International University, Department of Economics in its series Working Papers with number 0603.

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Length: 29 pages
Date of creation: May 2006
Date of revision:
Handle: RePEc:fiu:wpaper:0603

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Keywords: asset pricing; incomplete information; Kalman filter; equity returns; riskfree returns;

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  1. Collard, Fabrice & Fève, Patrick & Ghattassi, Imen, 2005. "Predictability and Habit Persistence," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 339, Institut d'Économie Industrielle (IDEI), Toulouse.
  2. Andrew B. Abel, 1990. "Asset Prices under Habit Formation and Catching up with the Joneses," NBER Working Papers 3279, National Bureau of Economic Research, Inc.
  3. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, Econometric Society, vol. 46(6), pages 1429-45, November.
  4. Detemple, Jerome B., 1991. "Further results on asset pricing with incomplete information," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 15(3), pages 425-453, July.
  5. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  6. Pok-sang Lam & Stephen G. Cecchetti & Nelson C. Mark, 2000. "Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True?," American Economic Review, American Economic Association, American Economic Association, vol. 90(4), pages 787-805, September.
  7. Detemple, Jerome B, 1986. " Asset Pricing in a Production Economy with Incomplete Information," Journal of Finance, American Finance Association, American Finance Association, vol. 41(2), pages 383-91, June.
  8. Gennotte, Gerard, 1986. " Optimal Portfolio Choice under Incomplete Information," Journal of Finance, American Finance Association, American Finance Association, vol. 41(3), pages 733-46, July.
  9. David, Alexander, 1997. "Fluctuating Confidence in Stock Markets: Implications for Returns and Volatility," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 32(04), pages 427-462, December.
  10. Kenneth A. Froot & Maurice Obstfeld, 1989. "Intrinsic Bubbles: The Case of Stock Prices," NBER Working Papers 3091, National Bureau of Economic Research, Inc.
  11. Brennan, Michael J. & Xia, Yihong, 2001. "Stock price volatility and equity premium," Journal of Monetary Economics, Elsevier, Elsevier, vol. 47(2), pages 249-283, April.
  12. Dothan, Michael U & Feldman, David, 1986. " Equilibrium Interest Rates and Multiperiod Bonds in a Partially Observable Economy," Journal of Finance, American Finance Association, American Finance Association, vol. 41(2), pages 369-82, June.
  13. Burnside, Craig, 1998. "Solving asset pricing models with Gaussian shocks," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 22(3), pages 329-340, March.
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