ABSTRACT: Two agents trade an indivisible
asset. They are risk neutral and share a common benchmark dividend
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.
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
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.
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.