Non-falsified Expectations and General Equilibrium Asset Pricing: The Power of the Peso

Jean-Pierre Danthine and John B Donaldson

Economic Journal, 1999, vol. 109, issue 458, 607-35

Abstract: We discuss the extent to which the expectation of a rare event which happens not to materialise over the sample period, but which is not rationally excludable from the set of possibilities--the peso problem--can affect the behaviour of rational agents and the characteristics of market equilibrium. To that end we describe quantitatively the macroeconomic and financial properties of a standard equilibrium business cycle model modified to allow for a very small probability of a depression state. We produce a model specification for which both business cycle characteristics and mean financial returns are in accord with United States observations.

Date: 1999
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Working Paper: Non-Falsified Expectations and General Equilibrium Asset Pricing: The Power of the Peso (1998)
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