Pricing Assets in an Economy with Two Types of People
37 Pages Posted: 9 May 2016 Last revised: 27 Mar 2023
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Pricing Assets in an Economy with Two Types of People
Pricing Assets in an Economy with Two Types of People
Date Written: May 2016
Abstract
This paper constructs a general equilibrium model with two types of people where asset price fluctuations are caused by random shocks to the 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 and financial assets across types. In my model, asset price fluctuations are Pareto inefficient and there is a role for treasury or central bank intervention to stabilize asset prices.
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