Working Paper: CEPR ID: DP10020
Authors: Tarek Hassan; Thomas M. Mertens
Abstract: We introduce the information microstructure of a canonical noisy rational expectations model (Hellwig, 1980) into the framework of a conventional real business cycle model. Each household receives a private signal about future productivity. In equilibrium, the stock price serves to aggregate and transmit this information. We find that dispersed information about future productivity affects the quantitative properties of our real business cycle model in three dimensions. First, households' ability to learn about the future affects their consumption-savings decision. The equity premium falls and the risk-free interest rate rises when the stock price perfectly reveals innovations to future productivity. Second, when noise trader demand shocks limit the stock market's capacity to aggregate information, households hold heterogeneous expectations in equilibrium. However, for a reasonable size of noise trader demand shocks the model cannot generate the kind of disagreement observed in the data. Third, even moderate heterogeneity in the equilibrium expectations held by households has a sizable effect on the level of all economic aggregates and on the correlations and standard deviations produced by the model. For example, the correlation between consumption and investment growth is 0.29 when households have no information about the future, but 0.41 when information is dispersed.
Keywords: asset prices; business cycles; dispersed information; investment; noisy rational expectations; portfolio choice
JEL Codes: C63; D83; E2; E3; E44; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| households' ability to learn about future productivity (J24) | consumption-saving decisions (E21) |
| dispersed information (D89) | equity premium (G12) |
| dispersed information (D89) | risk-free interest rate (E43) |
| noise trader demand shocks (E19) | heterogeneous expectations among households (D84) |
| moderate heterogeneity in expectations (D84) | economic aggregates (E10) |
| lack of information (D89) | correlation between consumption and investment growth (E20) |
| dispersed information (D89) | correlation between consumption and investment growth (E20) |