Information structure and equilibrium asset prices

In a continuous trading economy, it is shown that if information is revealed continuously and if agents' preferences are continuous in a certain topology, then equilibrium asset price processes must have continuous sample paths. Except for uninteresting cases, the sample paths of price processes will be of unbounded variation. In particular, if the information is generated by a Brownian motion,then equilibrium asset price processes are Ito integrals. When information is not revealed continuously, the times (which may be random) at which prices can have jumps are identified.     

Liquidity and asset prices in rational expectations equilibrium with ambiguous information

The quality of information in financial asset markets is often hard to estimate. Reminiscent of the famous Ellsberg paradox, investors may be unable to form a single probability belief about asset returns conditional on information signals and may act on the basis of ambiguous (or multiple) probability beliefs. This paper analyzes information transmission in asset markets when agents?? information is ambiguous. We consider a market with risk-averse informed investors, risk-neutral competitive arbitrageurs, and noisy supply of the risky asset, first studied by Vives (Rev Financ Stud 8:3?C40, 1995a, J Econ Theory 67:178?C204, 1995b) with unambiguous information. Ambiguous information gives rise to the possibility of illiquid market where arbitrageurs choose not to trade in a rational expectations equilibrium. When market is illiquid, small informational or supply shocks have relatively large effects on asset prices.     

On the impact of leverage constraints on asset prices and trading volume

Abstract. Researchers have used stylized facts on asset prices and trading volume in stock markets (in particular, the mean reversion of asset returns and the correlations between trading volume, price changes and price levels) to support theories where agents are not rational expected utility maximizers. This paper shows that this empirical evidence is in fact consistent with a standard infinite horizon – perfect information – expected utility economy where some agents face leverage constraints similar to those found in todays financial markets. In addition, and in sharp contrast to the theories above, we explain some qualitative differences that are observed in the price-volume relation on stock and on futures markets. We consider a continuous-time economy where agents maximize the integral of their discounted utility from consumption under both budget and leverage constraints. Building on the work by Vila and Zariphopoulou (1997), we find a closed form solution, up to a negative constant, for the equilibrium prices and demands in the region of the state space where the constraint is non-binding. We show that, at the equilibrium, stock holdings volatility as well as its ratio to stock price volatility are increasing functions of the stock price and interpret this finding in terms of the price-volume relation. We would like to thank the editor and two anonimous referees for valuable substantive comments. Our gratitude also to Franklin Allen, Kerry Back, Domenico Cuoco, Xavier Freixas, Sanford Grossman, Michel Habib, Lutz Hendricks, Richard Kihlstrom, Fernando Restoy, Mary Thomson, Jean-Luc Vila, participants to seminars at Birkbeck College, Carnegie-Mellon, Columbia, ESSEC, HEC, IAE, INSEAD, London Business School, London School of Economics, McGill, Michigan, National University of Singapore, Pompeu Fabra, North Carolina, Washington-St-Louis, Wharton, the Jornadas de Economía Financiera BBV, and the Meetings of the Society for Economic Dynamics and Control and the American Finance Association. Special thanks are due to Süleyman Basak for his enthusiastic support and many helpful suggestions. The usual disclaimer applies. We gratefully acknowledge the support of the BBV and Caja de Madrid Foundations and CREF (both authors) and of the Spanish Ministry of Education under DGICYT grant no. PB93-0388 (first author).     

Employment and asset prices

A medium-term relationship exists between share prices, normalized by labour productivity, and the rate of unemployment in the Organization for Economic Co-operation and Development (OECD) countries. This helps explain decadal changes in mean unemployment, such as the shift to higher mean unemployment in the Continental European countries in the 1970s and 1980s that coincided with a fall in the level of share prices, as well as differences in mean unemployment between countries.     

Risky arbitrage,asset prices,and externalities

We introduce a no-risky-arbitrage price condition (NRAP) for asset market models allowing both unbounded short sales and externalities such as trading volume. We then demonstrate that NRAP is sufficient for the existence of competitive equilibrium in the presence of externalities. Moreover, we show that if all risky arbitrages are utility increasing, then NRAP characterizes competitive equilibrium in the presence of externalities. We are indebted to an anonymous referee for helpful comments on an earlier version of this paper. Page and Wooders are especially grateful to CERMSEM and EUREQua for their support and hospitality which made possible our collaboration.     

Import prices,income, and inequality

We compare three theoretical explanations for the positive empirical relationship between importer income per capita and traded goods prices. A first explanation is that consumers with higher incomes demand higher quality goods with higher prices. A second explanation is that wealthier people exhibit an increased willingness to pay for necessary goods as more goods enter the consumption set in a hierarchic demand system, and can thus be charged higher markups. A third explanation is that consumers with higher incomes are more finicky regarding their preferred variety in an ideal variety framework and can thus be charged higher markups. We discriminate between these three theories by focusing on the effect of income inequality on trade prices. Based on a large dataset with bilateral HS6 level data on 1260 final goods categories from more than 100 countries between 2000 and 2004, we find a highly significant negative effect of income inequality on unit values. This contradicts both the demand for quality and finickyness theories, while providing support for the increased willingness to pay theory linked to hierarchic demand. These findings on income inequality do not falsify the quality expansion model and the ideal variety model per se. However, the results do argue for place of importance of hierarchic demand.     

Income distribution, borrowing constraints and redistributive policies

This paper sheds light on the relationship between income inequality and redistributive policies and provides possible guidance in the specification of empirical tests of such a relationship. We model a two-period economy where capital markets are imperfect and agents vote over the level of taxation to finance redistributive policies that enhance future productivity. In this context, we show that the pivotal voter is not necessarily the agent (class) with median income. In particular, the poor, who are more likely to be liquidity constrained, may form a coalition with the rich and vote for low redistribution. The effects of an increase in income inequality on the level of redistribution turn out to depend on whether the increase in inequality is concentrated among the poor or the middle class. Empirical results from a panel of 22 OECD countries provide preliminary evidence consistent with our main theoretical implications.     

Skewness preferences,asset prices and investor sentiment

Prior research has found that investors have strong preferences for stocks with positive skewness. These preferences have been shown to lead to price premiums and subsequent underperformance. This study extends this growing body of literature by testing whether the underperformance of stocks with positive skewness is driven by periods of high investor sentiment. The motivation for these tests is based on a broad literature in Psychology that an individual’s mood can directly affect the individual’s subjective probability assessments. In the framework of our tests, more optimism among investors may strengthen investors’ skewness preferences. The empirical results in this study support this idea as the underperformance of positively skewed stocks is shown to be primarily driven by periods of high investor sentiment.     

Monetary confidence and asset prices

Three issues are studied in this paper: the existence of sunspot equilibria; the excessive volatility of asset prices; and the possibility that assets may be undervalued relative to their market fundamentals. We show that (i) stationary sunspot equilibria exist in a very general environment; (ii) asset prices may fluctuate despite a constant stream of dividends; and (iii) assets may be undervalued. JEL: 021, 023, 131.     

Speculative trade, asset prices and investment levels

Summary. In this paper I consider a dynamically complete market model without intrinsic uncertainty. Agents' beliefs are different, but correct in the limit. Some agents are more patient than others. I show that infinitely often share prices are low and the economy stagnates. Also, infinitely often share prices are high and the economy grows. The changes from growth to stagnation and from stagnation to growth are not caused by exogenous shocks. They are caused by speculative trade among agents with different propensities to save and invest. Received: January 8, 2001; revised version: April 11, 2002 RID="*" ID="*" I thank an anonymous referee for helpful comments. I gratefully acknowledge financial support from the National Science Foundation.     

Monetary policy and asset prices

The purpose of this paper is study the effect of monetary policy on asset prices. We study the properties of a monetary model in which a real asset is valued for its rate of return and for its liquidity. We show that money is essential if and only if real assets are scarce, in the precise sense that their supply is not sufficient to satisfy the demand for liquidity. Our model generates a clear connection between asset prices and monetary policy. When money grows at a higher rate, inflation is higher and the return on money decreases. In equilibrium, no arbitrage amounts to equating the real return of both objects. Therefore, the price of the asset increases in order to lower its real return. This negative relationship between inflation and asset returns is in the spirit of research in finance initiated in the early 1980s.     

On non-ergodic asset prices

We investigate the asset prices dynamics and the long-run market shares of two competing financial mediators who are selected by consumers. We demonstrate that the social interaction among consumers constitutes an endogenous path-depending source of risk in a financial market. Depending on consumers’ evaluation of the mediator’s investment, asset prices may behave in a non-ergodic manner: the price process converges in distribution but the limiting distribution is not necessarily uniquely determined, its multiplicity being characterized by the multiplicity of possible long-run market shares. The convergence of the process is sensitive to initial conditions and depends on the history of noise-trader transactions. Long-run portfolio holdings may be in-efficient since investors holding mean-variance efficient portfolios may not be identified.     

Quantifying borrowing constraints and precautionary savings

This paper quantifies the effects of precautionary savings. It demonstrates that Zeldes' estimate of excess consumption growth for low asset holders is consistent with a dynamic general equilibrium model with uninsurable endowment shocks when borrowing is constrained at three months' worth of average wage income. I propose a Monte Carlo simulation of the stationary equilibrium as a method of indirectly testing the hypotheses of a no-borrowing specification and a natural debt limit specification. At the estimated borrowing constraint, an increase in endowment shocks within the range of empirical findings can cause a 1.6% increase in the savings rate and a 6.9% increase in capital.     

Excess demand functions, equilibrium prices, and existence of equilibrium

Summary. For continuous aggregate excess demand functions of economies, the existing literature (e.g. Sonnenschein (1972, 1973), Mantel (1974), Debreu (1974), Mas-Colell (1977), etc.) achieves a complete characterization only when the functions are defined on special subsets of positive prices. In this paper, we allow the functions to be defined on a larger class of price sets, (allowing, for example the closed unit simplex, including its boundary). Besides characterizing excess demands for a larger class of economies, our extension provides a useful tool for proving other results. It allows us to characterize the equilibrium price set for a larger class of economies. It also permits extending Uzawa's observation (1962), by showing that Brouwer's Fixed-Point Theorem is implied by the Arrow-Debreu Equilibrium Existence Theorem (1954, Theorem I). Received: October 18, 1995; revised version June 28, 1996     

Unconventional monetary policy,liquidity trap,and asset prices

This article offers a fundamental critique of monetary policy implemented in the United States following the 2007–8 global financial crisis. It aims to show that the misunderstanding of the mainstream theoretical thinking underlying monetary policy actions led to the ineffectiveness of the policy response to the 2007–8 global financial crisis. The conventional view that monetary policy is the stabilization tool has serious flaws and is ineffective for bringing about economic recovery. The Federal Reserve’s experiment with the so-called unconventional monetary policy exposed the weakness of the conventional belief in understanding how banks operate, how the monetary authority can influence the yield curve, and how the monetary transmission mechanism works, resulting in prescribing an ineffective treatment to boost economic activity. In this regard, it is argued that the Federal Reserve’s decision to let long-term interest rates be market determined represents a significant self-imposed constraint, which limits policy options regarding monetary policy actions and the effective control of long-term interest rates. By limiting the setting of policy rates only to the overnight interest rate, the ability of the monetary authority to influence long-term interest rates is both weak and indirect.     

Internal rationality, imperfect market knowledge and asset prices

We present a decision theoretic framework in which agents are learning about market behavior and that provides microfoundations for models of adaptive learning. Agents are ‘internally rational’, i.e., maximize discounted expected utility under uncertainty given dynamically consistent subjective beliefs about the future, but agents may not be ‘externally rational’, i.e., may not know the true stochastic process for payoff relevant variables beyond their control. This includes future market outcomes and fundamentals. We apply this approach to a simple asset pricing model and show that the equilibrium stock price is then determined by investors? expectations of the price and dividend in the next period, rather than by expectations of the discounted sum of dividends. As a result, learning about price behavior affects market outcomes, while learning about the discounted sum of dividends is irrelevant for equilibrium prices. Stock prices equal the discounted sum of dividends only after making very strong assumptions about agents? market knowledge.     

Asset prices, debt constraints and inefficiency

We consider (possibly non-stationary) economies with endogenous solvency constraints under uncertainty over an infinite horizon, as in Alvarez and Jermann (2000) [5]. A sort of Cass Criterion (Cass, 1972 [10]) completely characterizes constrained inefficiency under the hypothesis of uniform gains from risk-sharing (which is always satisfied in stationary economies when the autarchy is constrained inefficient). Uniform gains from risk-sharing also guarantee a finite value of the intertemporal aggregate endowment at a constrained optimum. Hence, no equilibrium exhibits a null interest rate in the long run. Finally, constrained inefficiency occurs if and only if there exists a feasible redistribution producing a welfare improvement at all contingencies.     

Robust asset prices with bubbles

We generally establish equilibrium asset prices than can include price bubbles yet (a) be robust to truncations of the economy and (b) exclude trade in non-consumables, like money, stock certificates, or land deeds.