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Micro frictions, asset pricing, and aggregate implications

Favilukis, Jack and Lin, Xiaoji (2011) Micro frictions, asset pricing, and aggregate implications. . (Unpublished)

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Abstract

We study the implications of recent advances in the asset pricing literature on investment, and vice versa in a DSGE model with non-trivial heterogeneity in production units, lumpy investment, and long run productivity risk. We make three contributions. First, for aggregate asset pricing, investment frictions do not change the price of risk; in fact even a frictionless model can deliver a high price of risk. Second, the failure of production models in producing a high volatility of equity is likely due to failures in matching the joint dynamics of profit, wage, and dividend rather than to investment frictions. We provide an experiment to show a promising mechanism that is useful for future research in this area. Third, for aggregate investment, long run productivity risk can produce heteroscedasticity and history dependence in aggregate investment rate, providing an alternative to the Bachmann, Caballero, and Engel (2010) explanation of these phenomena.

Item Type: Monograph (Working Paper)
Additional Information: © 2012 The Authors
Library of Congress subject classification: H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
Journal of Economic Literature Classification System: E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E23 - Production
E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
Sets: Departments > Finance
Collections > Economists Online
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Date Deposited: 16 Apr 2012 14:23
URL: http://eprints.lse.ac.uk/43131/

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