Working Paper: CEPR ID: DP12643
Authors: Roger E. A. Farmer
Abstract: This paper constructs a general equilibrium model where asset price fluctuations are caused by random shocks to beliefs about the future price level that reallocate consumption across generations. In this model, asset prices are volatile, and price-earnings ratios are persistent, even though there is no fundamental uncertainty and financial markets are sequentially complete. I show that the model can explain a substantial risk premium while generating smooth time series for consumption. In my model, asset price fluctuations are Pareto inefficient and there is a role for treasury or central bank intervention to stabilize asset price volatility.
Keywords: No keywords provided
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| belief shocks (D83) | asset price fluctuations (G19) |
| asset price fluctuations (G19) | consumption across generations (D15) |
| belief shocks (D83) | persistent asset price volatility (G19) |
| belief shocks (D83) | substantial risk premium (G12) |
| government intervention (O25) | stabilization of asset price fluctuations (E63) |
| belief shocks (D83) | Pareto inefficiency of asset price fluctuations (G19) |