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Thomas Mertens - New York University
Friday 07 March 2014, 05:30pm - 07:00pm

Information Aggregation in DSGE Models

Abstract:

We solve and quantitatively analyze a canonical noisy rational expectations model (Hellwig,1980) within the framework of a conventional real business cycle model. Each household receives a private signal about future productivity. In equilibrium, the stock price serves to aggregate and transmit this information. We find that dispersed information about future productivity affects the quantitative properties of our real business cycle model in three dimensions. First, households’ ability to learn about the future has a large effect on their consumption-savings decision. The equity premium falls by 87% and the risk-free interest rate rises by 100% when the stock price perfectly reveals innovations to future productivity. Second, when noise trader demand shocks limit the stock market’s capacity to aggregate information, households hold heterogeneous expectations in equilibrium. However, for a reasonable size of noise trader demand shocks the model cannot generate the kind of disagreement observed in the data. Third, even moderate heterogeneity in the equilibrium expectations held by households affects the correlations and standard deviations produced by the model. For example, the correlation between consumption and investment growth is 0.29 when households have no information about the future, but 0.41 when information is dispersed.

   
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