JOURNAL ARTICLE

Trendy Business Cycles and Asset Prices.

  • Published In: Review of Financial Studies, 2023, v. 36, n. 6. P. 2509 1 of 3

  • Database: Business Source Ultimate 2 of 3

  • Authored By: Davis, Jesse; Segal, Gill 3 of 3

Abstract

The article investigates how agents' imperfect information about productivity shocks—specifically, the inability to distinguish in real time between permanent trend shocks and transitory business cycle shocks—creates "rational confusion," whereby each shock inherits characteristics of the other. This learning process significantly alters macroeconomic dynamics and asset pricing outcomes in a production-based general equilibrium model with recursive preferences. Under imperfect information, transitory business cycle shocks become the primary source of long-run consumption risk and the main driver of the equity premium, reversing the canonical view that permanent trend shocks dominate long-run risk. The model reconciles empirical observations such as a positive equity premium, procyclical investment and valuation ratios, and realistic term structures of risk, highlighting the crucial role of learning and flexible investment in shaping risk exposures and prices.

Additional Information

  • Source:Review of Financial Studies. 2023/06, Vol. 36, Issue 6, p2509
  • Document Type:Article
  • Subject Area:Economics
  • Publication Date:2023
  • ISSN:0893-9454
  • DOI:10.1093/rfs/hhac084
  • Accession Number:163826622
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