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Asset Prices in a News Driven Real Business Cycle Model

Listed author(s):
  • Maral Shamloo

    (International Monetary Fund)

  • Aytek Malkhozov

    (London School of Economics)

We examine the implications of introducing anticipated productivity shocks for the ability of a real-business-cycle model to explain asset prices. Our theoretical framework is a real-business-cycle model in which agents receive news about future productivity shocks. We show that incorporating anticipated shocks, or news, creates a persistent predictable component in consumption growth, often referred to as long-run risk in the finance literature (Bansal and Yaron, 2004). Thus, in conjunction with Epstein and Zin (1989) preferences and under plausible parameter calibrations, news shocks help explain key observed asset pricing facts. Furthermore, we show that news shocks improve our prediction for the co-movement of macroeconomic and financial variables, and explain the asset returns' lead over the business cycle. We also model time-varying economic uncertainty (stochastic volatility), and show how under certain conditions this could lead to lower premia in a model where consumption is endogenous. Finally, we discuss how a class of dynamic stochastic general equilibrium models with recursive preferences can be solved using perturbation methods, which are more computationally efficient than the usual numerical techniques.

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File URL: https://economicdynamics.org/meetpapers/2010/paper_546.pdf
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Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 546.

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Date of creation: 2010
Handle: RePEc:red:sed010:546
Contact details of provider: Postal:
Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. Paul Beaudry & Franck Portier, 2004. "Stock Prices, News and Economic Fluctuations," NBER Working Papers 10548, National Bureau of Economic Research, Inc.
  2. Maral Shamloo & Aytek Malkhozov, 2010. "Asset Prices in Affine Real Business Cycle Models," IMF Working Papers 10/249, International Monetary Fund.
  3. John Y. Campbell & Robert J. Shiller, 1988. "Stock Prices, Earnings and Expected Dividends," Cowles Foundation Discussion Papers 858, Cowles Foundation for Research in Economics, Yale University.
  4. Claudio Campanale & Rui Castro & Gian Luca Clementi, 2007. "Asset Pricing in a Production Economy with Chew-Dekel Preferences," Working Papers 07-12, New York University, Leonard N. Stern School of Business, Department of Economics.
  5. Jason Beeler & John Y. Campbell, 2009. "The Long-Run Risks Model and Aggregate Asset Prices: An Empirical Assessment," NBER Working Papers 14788, National Bureau of Economic Research, Inc.
  6. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-969, July.
  7. Lars Peter Hansen & Ravi Jagannathan, 1990. "Implications of Security Market Data for Models of Dynamic Economies," NBER Technical Working Papers 0089, National Bureau of Economic Research, Inc.
  8. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc.
  9. Nir Jaimovich & Sergio Rebelo, 2006. "Can News About the Future Drive the Business Cycle?," NBER Working Papers 12537, National Bureau of Economic Research, Inc.
  10. Michele Boldrin & Lawrence J. Christiano & Jonas D. M. Fisher, 2000. "Habit persistence, asset returns and the business cycle," Staff Report 280, Federal Reserve Bank of Minneapolis.
  11. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
  12. Restoy, Fernando & Rockinger, G Michael, 1994. " On Stock Market Returns and Returns on Investment," Journal of Finance, American Finance Association, vol. 49(2), pages 543-556, June.
  13. Fernando Alvarez & Urban J. Jermann, 2005. "Using Asset Prices to Measure the Persistence of the Marginal Utility of Wealth," Econometrica, Econometric Society, vol. 73(6), pages 1977-2016, November.
  14. Ramey, Garey & Ramey, Valerie A, 1995. "Cross-Country Evidence on the Link between Volatility and Growth," American Economic Review, American Economic Association, vol. 85(5), pages 1138-1151, December.
  15. TallariniJr., Thomas D., 2000. "Risk-sensitive real business cycles," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 507-532, June.
  16. Ravi Bansal & Amir Yaron, 2000. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," NBER Working Papers 8059, National Bureau of Economic Research, Inc.
  17. Claudio Campanale & Rui Castro & Gian Luca Clementi, 2007. "Asset Pricing in a Production Economy with ChewÐDekel Preferences," Working Paper Series 07_07, The Rimini Centre for Economic Analysis.
  18. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-131, February.
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