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.