Pricing Assets in an Economy with Two Types of People

Roger Farmer

No 11253, CEPR Discussion Papers from Centre for Economic Policy Research

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.

Date: 2016-04
New Economics Papers: this item is included in nep-dge
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Working Paper: Pricing Assets in an Economy with Two Types of People (2016)
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