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UBC Theses and Dissertations

Investor information and asset returns in production economies Wang, Shubo

Abstract

In this thesis, I explore the implications of investor information for asset returns in general equilibrium economies with production. In the first chapter, I study what determines the relationship between information quality and long-run risk in a Cox-Ingersoll-Ross type model with recursive preferences. Building on the recent work by Ai (2010), I separate the risk premium into the short-run and long-run components to highlight aspects of preferences that are important for this relationship. It is shown that the attitude towards temporal resolution of uncertainty determines the direction in which changes in information quality alter the compensation for long-run risk, while the elasticity of intertemporal substitution is important for the amplitude of this effect. In the second chapter, I investigate how incomplete information affects asset returns in a real business cycle model with Epstein-Zin preferences. In the model economy, productivity is altered by both transitory and permanent shocks. The representative agent observes movements in productivity but cannot perfectly distinguish their sources. As a result he must solve a signal extraction problem. This incomplete information model is found to be quantitatively consistent with some common observations about asset prices and aggregate quantities, including, for example, the equity premium, the risk-free rate, the price-dividend ratio and the dynamics of consumption and output. Furthermore, the model generates a downward sloping term structure of equity risk as empirically observed-namely, assets with short-duration of cash flows have larger risk premium and return volatility than assets with long-duration of cash flows.

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Attribution-NonCommercial-NoDerivatives 4.0 International

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