ABSTRACT: Two agents trade an indivisible
asset. They are risk neutral and share a common benchmark dividend
model.
However, each
has doubts about the specification of this model. These doubts
manifest themselves as a preference for
robustness
(Hansen and Sargent (2008)). Robust preferences introduce pessimistic
drift distortions into the benchmark
dividend process.
These distortions increase with the level of wealth, and give
rise to endogenous heterogeneous beliefs.
Belief heterogeneity
allows asset price bubbles to emerge, as in Scheinkman and Xiong
(2003). A novel implication of
our analysis
is that bubbles occur when wealth inequality increases. Empirical
evidence supports this prediction. Detection
error probabilities
suggest that the implied degree of belief heterogeneity is empirically
plausible.
Ambiguity and
Information Processing in a Model of Intermediary Asset Pricing
(with Leyla Jianyu Han
and Yulei Luo)
ABSTRACT: This paper incorporates
ambiguity and information processing constraints into a model of
intermediary asset
pricing. Financial intermediaries
are assumed to possess greater information processing capacity. Households
purchase this
capacity, and then delegate their
investment decisions to intermediaries. As in He and Krishnamurthy
(2012), the delegation
contract is constrained by a moral
hazard problem, which gives rise to a minimum capital requirement.
Both agents have a
preference for robustness,
reflecting ambiguity about asset returns (Hansen and Sargent (2008)).
We show that ambiguity
tightens the capital constraint,
and amplifies its effects.
Indirect inference
is used to calibrate the model's parameters to the stochastic properties
of asset returns. Detection error
probabilities are used to
discipline the degree of ambiguity aversion. The model can explain
both the unconditional moments
of asset returns and their
state dependence, even with DEPs in excess of 20%.
A Behavioral Defense of Rational Expectations
ABSTRACT: This paper studies decision
making by agents who value optimism, but are unsure of their environment.
As in
Brunnermeir and
Parker (2005), an agent's optimism is assumed to be tempered by
the decision costs it imposes. As in
Hansen and Sargent
(2008), an agent's uncertainty about his environment leads him
to formulate `robust' decision rules. It is
shown that when
combined, these two considerations can lead agents to adhere
to the Rational Expectations Hypothesis.
Rather than being
the outcome of the sophisticated statistical calculations of
an impassive expected utility maximizer, Rational
Expectations can
instead be viewed as a useful approximation in environments where
agents struggle to strike a balance
between doubt and
hope.