| By: |
Prasad V. Bidarkota (Department of Economics, Florida International University);
Brice V. Dupoyet (Department of Finance, Florida International University);
J. Huston McCulloch (Department of Economics, Ohio State University) |
| Abstract: |
We study a consumption based asset pricing model with incomplete information
and alpha-stable shocks. Incomplete information leads to a non-Gaussian
filtering problem. Bayesian updating generates fluctuating confidence in the
agents' estimate of the persistent component of the dividends’ growth rate.
Similar results are obtained with alternate distributions exhibiting fat tails
(Extreme Value distribution, Pearson Type IV distribution) while they are not
with a thin-tail distribution (Binomial distribution). This has the potential
to generate time variation in the volatility of model-implied returns, without
relying on discrete shifts in the drift rate of dividend growth rates. A test
of the model using US consumption data indicates strong support in the sense
that the implied returns display significant volatility persistence of a
magnitude comparable to that in the data. |
| Keywords: |
asset pricing, incomplete information, time-varying volatility, fat tails, stable distributions |
| JEL: |
G12 G13 E43 |
| Date: |
2005–09 |
| URL: |
http://d.repec.org/n?u=RePEc:fiu:wpaper:0514&r=cfn |