Asset price volatility in a nonconvex general equilibrium model

Costas Azariadis and Shankha Chakraborty

Economic Theory, 1998, vol. 12, issue 3, 649-665

Abstract: Asset prices and returns are known to vary significantly more than output or aggregate consumption growth, and an order of magnitude in excess of what is justified by innovations to fundamentals. We study excess price volatility in a lifecycle economy with two assets (claims on capital and a public debt bubble), heterogeneous agents, and increasing returns to financial intermediation. We show that a relatively modest nonconvexity generates a set valued equilibrium correspondence in asset prices, with two stable branches. Price volatility is the outcome of an equilibrium selection mechanism, which mixes adaptive learning with "noise", and alternates stochastically between the two stable branches of the price correspondence.

Keywords: Private; information; ·; Costly; state; verification; ·; Asset; price; volatility; ·; Cycles. (search for similar items in EconPapers)
JEL-codes: E32 E44 G12 G14 (search for similar items in EconPapers)
Date: 1998-10-13
Note: Received: March 19, 1998; revised version: June 2, 1998
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