Information Aggregation in a Dynamic Stochastic General Equilibrium Model

Tarek A. Hassan, Thomas M. Mertens

Chapter in NBER book NBER Macroeconomics Annual 2014, Volume 29 (2015), Jonathan A. Parker and Michael Woodford, editors (p. 159 - 207)
Conference held April 11-12, 2014
Published in July 2015 by University of Chicago Press
© 2015 by the National Bureau of Economic Research
in NBER Book Series NBER Macroeconomics Annual

We introduce the information microstructure of a canonical noisy rational expectations model (Hellwig, 1980) into 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 aff ects the quantitative properties of our real business cycle model in three dimensions. First, households' ability to learn about the future a ffects their consumption-savings decision. The equity premium falls and the risk-free interest rate rises 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 has a sizable eff ect on the level of all economic aggregates and on 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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This paper was revised on May 29, 2014

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This chapter first appeared as NBER working paper w20193, Information Aggregation in a DSGE Model, Tarek A. Hassan, Thomas M. Mertens
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