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Stochastic Growth with Short-run Prediction of Shocks

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  • Roy, Santanu
  • Zilcha, Itzhak

Abstract

We study a one sector stochastic growth model with independent and identically dis- tributed shocks where agents acquire information that enables them to accurately predict next period's productivity shock (but not shocks in later periods). Optimal policy de- pends on the forthcoming shock. We derive conditions under which a more productive realization of the forthcoming shock increases or decreases current investment; relative risk aversion and the elasticity of marginal product play important roles in these condi- tions. A better shock always increases next period's optimal output if it increases both marginal and total product. We derive explicit solutions to the optimal policy function for three well known families of production and utility functions. Volatility of output, sensitivity of output to shocks and expected total investment may be higher or lower than in the standard stochastic growth model where no new information is acquired over time. Under restrictions similar to that used in the standard model, optimal outputs converge in distribution to a unique invariant distribution whose support is bounded away from zero; the limiting distribution may differ from that obtained in the standard model.

Suggested Citation

  • Roy, Santanu & Zilcha, Itzhak, 2012. "Stochastic Growth with Short-run Prediction of Shocks," Foerder Institute for Economic Research Working Papers 275773, Tel-Aviv University > Foerder Institute for Economic Research.
  • Handle: RePEc:ags:isfiwp:275773
    DOI: 10.22004/ag.econ.275773
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    Cited by:

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    2. Takashi Kamihigashi, 2014. "Elementary results on solutions to the bellman equation of dynamic programming: existence, uniqueness, and convergence," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 56(2), pages 251-273, June.
    3. Takashi Kamihigashi, 2014. "An order-theoretic approach to dynamic programming: an exposition," Economic Theory Bulletin, Springer;Society for the Advancement of Economic Theory (SAET), vol. 2(1), pages 13-21, April.

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    More about this item

    Keywords

    Financial Economics;

    JEL classification:

    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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