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Non-falsified Expectations and General Equilibrium Asset Pricing: The Power of the Peso

Author

Listed:
  • Danthine, Jean-Pierre
  • Donaldson, John B
Abstract
We discuss the extent to which the expectation of a rare event which happens not to materialise over the sample period, but which is not rationally excludable from the set of possibilities--the peso problem--can affect the behaviour of rational agents and the characteristics of market equilibrium. To that end we describe quantitatively the macroeconomic and financial properties of a standard equilibrium business cycle model modified to allow for a very small probability of a depression state. We produce a model specification for which both business cycle characteristics and mean financial returns are in accord with United States observations.

Suggested Citation

  • Danthine, Jean-Pierre & Donaldson, John B, 1999. "Non-falsified Expectations and General Equilibrium Asset Pricing: The Power of the Peso," Economic Journal, Royal Economic Society, vol. 109(458), pages 607-635, October.
    • Handle: RePEc:ecj:econjl:v:109:y:1999:i:458:p:607-35
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    Citations

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    Cited by:

    1. Massimo Guidolin, 2006. "High equity premia and crash fears - Rational foundations," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 28(3), pages 693-708, August.
    2. Satyajit Chatterjee & Dean Corbae, 2000. "On the welfare gains of reducing the likelihood of economic crises," Working Papers (Old Series) 0015, Federal Reserve Bank of Cleveland.
    3. Veronesi, Pietro, 2004. "The Peso problem hypothesis and stock market returns," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 707-725, January.
    4. Natalia Gershun, 2004. "Macrodynamic and Financial Effects of a Large-Scale Technology Change," International Journal of Business and Economics, School of Management Development, Feng Chia University, Taichung, Taiwan, vol. 3(1), pages 67-81, April.
    5. Satyajit Chatterjee & Dean Corbae, 2003. "On the welfare gains of eliminating a small likelihood of economic crises: A case for stabilization policies?," Working Papers 03-20, Federal Reserve Bank of Philadelphia.
    6. Guidolin, Massimo, 2006. "Pessimistic beliefs under rational learning: Quantitative implications for the equity premium puzzle," Journal of Economics and Business, Elsevier, vol. 58(2), pages 85-118.
    7. Geoffrey J. Warren, 2008. "Implications for Asset Pricing Puzzles of a Roll‐over Assumption for the Risk‐Free Asset," International Review of Finance, International Review of Finance Ltd., vol. 8(3‐4), pages 125-157, September.
    8. Lu Zhang & Howard Kung & Hang Bai, 2013. ""Shooting" the CAPM," 2013 Meeting Papers 905, Society for Economic Dynamics.
    9. G. A. Christodoulakis & E. C. Mamatzakis, 2009. "Assessing the prudence of economic forecasts in the EU," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 24(4), pages 583-606.
    10. Bai, Hang & Hou, Kewei & Kung, Howard & Zhang, Lu, 2015. "The CAPM Strikes Back? An Investment Model with Disasters," Working Paper Series 2015-03, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    11. Laurian Lungu & Patrick Minford, 2006. "Explaining The Equity Risk Premium," Manchester School, University of Manchester, vol. 74(6), pages 670-700, December.
    12. Groth, Charlotta & Zampolli, Fabrizio, 2010. "Macroeconomic stability and the real interest rate: a cross-country analysis," Discussion Papers 30, Monetary Policy Committee Unit, Bank of England.
    13. Bai, Hang & Hou, Kewei & Kung, Howard & Li, Erica X.N. & Zhang, Lu, 2019. "The CAPM strikes back? An equilibrium model with disasters," Journal of Financial Economics, Elsevier, vol. 131(2), pages 269-298.
    14. Robert J. Barro & Jose F. Ursua, 2008. "Macroeconomic Crises since 1870," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 39(1 (Spring), pages 255-350.
    15. George M. Constantinides, 2006. "Market Organization And The Prices Of Financial Assets," Manchester School, University of Manchester, vol. 74(s1), pages 1-23, September.
    16. Mertens, Karel, 2007. "The Role of Expectations in Sudden Stops," Working Papers 07-10, Cornell University, Center for Analytic Economics.

    More about this item

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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