Working Paper: NBER ID: w14814
Authors: Ravi Bansal; Ivan Shaliastovich
Abstract: We develop a general equilibrium model in which income and dividends are smooth, but asset prices are subject to large moves (jumps). A prominent feature of the model is that the optimal decision of investors to learn the unobserved state triggers large asset-price jumps. We show that the learning choice is critically determined by preference parameters and the conditional volatility of income process. An important prediction of the model is that income volatility predicts future jumps, while the variation in the level of income does not. We find that indeed in the data large moves in returns are predicted by consumption volatility, but not by the changes in the consumption level. We show that the model can quantitatively capture these novel features of the data.
Keywords: Asset Prices; Learning; Volatility; Jumps
JEL Codes: E0; E4; E44; G0; G1; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| High consumption volatility (E21) | Increased learning about the economic state (E29) |
| Increased learning about the economic state (E29) | Significant asset price adjustments (G19) |
| High consumption volatility (E21) | Significant asset price adjustments (G19) |