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Perspectives on asset pricing in dynamic production economies

Natalia Gershun, 2003
Faculty Advisor: John B. Donaldson

Abstract

This thesis is an attempt to further an understanding of asset pricing puzzles in the dynamic general equilibrium economies with production sector. The first essay examines the effect of a large-scale technology change on asset prices, when this change is actually present in the sample and when it is expected but not observed in the sample (peso phenomenon). I find that in peso samples the possibility of a large-scale change in technology helps to resolve an equity premium puzzle. The second part of the thesis (third and fourth essays) explores the behavior of financial asset returns in dynamic production economies with multiple rational equilibria (aka indeterminacy). These economies feature variable capacity utilization of the capital stock and increasing returns to scale. The results indicate that the possibility of multiple equilibria does not significantly improve results of dynamic models with variable capacity utilization and without local indeterminacy. Equity premium, risk-free rate and volatility puzzles are not resolved to the satisfactory level. The forth essay investigates whether modifications of the model with variable capacity utilization fair better along financial dimensions. These modifications, such as habit formation, adjustment costs and risk sharing labor contracts, are known to improve asset-pricing performance of the traditional dynamic general equilibrium models. In this research they are incorporated into a multiple equilibrium framework. There are two interesting questions that arise. First, no one has explored the question whether these modifications are compatible with multiple equilibria. Second, it is important to find out whether they play the same role for asset prices in the models with indeterminacy as they do in the traditional dynamic models, i.e. help resolve financial puzzles. The results show that all modifications except for the risk sharing labor contracts are consistent with indeterminacy in economies with variable capacity utilization, but they do not have a significant impact on asset returns.

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