Asset Prices in an Economy with Latent Technological Shocks - Econometric Implications of a Discrete Time General Equilibrium Model

The Paper Has Two Major Parts. the First Part Focuses on the Theoretical Properties of a General Equilibrium Asset Price Model Describing an Economy with Actual Output Stochastically Generated by a Markovian Latent Process of Technolgical Shocks. with a Concealed State Space Economy, Agents Make Use of the Entire Observed History to Make Inference About the Latent Technological Shock. Instead of Focussing on the Entire History of Output, Past Events Are Summarized by a Conditional Probability Distribution Defined on the Space of All Possible States of Technology. Bayesian Updating Reestablishes Markovian Recursive Dynamics, and Allows One to Exploit the Analytical Tools Introduced by Lucas (1978) in Solving for Equilibrium Asset Prices. the Second Part of the Paper Deals with the Econometric Implications of the Model. the Consumption and Portfolio Decisions Can Be Expressed As Time Invariant Functions Defined on the Transformed State Space, I.E. the Space of Conditional Probability Distributions on the State of Nature At Any Point in Time. This Does Not Necessarily Imply That the Co-Movements of Consumption, Portfolio Decisions, Output and Asset Prices Are Stationary. We Formulate a Gaussian Model, Very Similar to Hansen and Singleton (1983) and Estimate It Via a State Space Representation Which Incorporates the Rational Expectations Equilibrium Cross-Equation Restriction.