Learning and Asset-Price Jumps
55 Pages Posted: 13 Mar 2009 Last revised: 13 Dec 2011
Date Written: October 19, 2009
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 the conditional volatility of income predicts future jump periods, while the level of income growth does not. We find that indeed in the data large moves in returns are predicted by consumption volatility, but not by the changes in consumption level. We show that the model can quantitatively capture these novel features of the data.
Keywords: Recursive utility, learning, asset price jumps
JEL Classification: G12, C22, D83
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