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73
If You’re So Smart, Why Aren’t You Rich? Belief Selection in Complete and Incomplete Markets
, 2001
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General equilibrium with incomplete markets: A comment, Essays in honor of John Hicks, forthcoming
, 1989
"... I survey the major results in the theory of general equilibrium with incomplete asset markets. I ..."
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Cited by 30 (0 self)
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I survey the major results in the theory of general equilibrium with incomplete asset markets. I
Collateral Shortages, Asset Price and Investment Volatility with Heterogeneous Beliefs
"... The recent economic crisis highlights the role of financial markets in allowing economic agents, including prominent banks, to speculate on the future returns of different financial assets, such as mortgagebacked securities. This paper introduces a dynamic general equilibrium model with aggregate s ..."
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Cited by 21 (1 self)
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The recent economic crisis highlights the role of financial markets in allowing economic agents, including prominent banks, to speculate on the future returns of different financial assets, such as mortgagebacked securities. This paper introduces a dynamic general equilibrium model with aggregate shocks, potentially incomplete markets and heterogeneous agents to investigate this role of financial markets. In addition to their risk aversion and endowments, agents differ in their beliefs about the future aggregate states of the economy. The difference in beliefs induces them to take large bets under frictionless complete financial markets, which enable agents to leverage their future wealth. Consequently, as hypothesized by Friedman (1953), under complete markets, agents with incorrect beliefs will eventually be driven out of the markets. In this case, they also have no influence on asset prices and real investment in the long run. In contrast, I show that under incomplete markets generated by collateral constraints, agents with heterogeneous (potentially incorrect) beliefs survive in the long run and their speculative activities drive up asset price volatility and real investment volatility permanently. I also show that collateral constraints are always binding even if the supply of collateralizable assets endogenously responds to their price. I use this framework to study the e¤ects of di¤erent types of regulations and the distribution of endowments on leverage, asset price volatility and investment. Lastly, the analytical tools developed in this framework enable me to prove the existence of the recursive equilibrium in Krusell and Smith (1998) with a finite number of types. This has been an open question in the literature.
Default and punishment in general equilibrium
 Econometrica
"... We extend the standard model of general equilibrium with incomplete markets to allow for default and punishment. The equilibrating variables include expected delivery rates, along with the usual prices of assets and commodities. By reinterpreting the variables, our model encompasses a broad range of ..."
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Cited by 19 (5 self)
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We extend the standard model of general equilibrium with incomplete markets to allow for default and punishment. The equilibrating variables include expected delivery rates, along with the usual prices of assets and commodities. By reinterpreting the variables, our model encompasses a broad range of adverse selection and signalling phenomena (including the Akerlof lemons model and the Rothschild—Stiglitz insurance model) in a general equilibrium framework. Despite earlier claims about the nonexistence of equilibrium with adverse selection, we show that equilibrium always exists. We show that more lenient punishment which encourages default may be Pareto improving because it increases the dimension of the asset span without increasing the number of assets traded. We deÞne an equilibrium reÞnement that requires expected delivery rates for untraded assets to be reasonably optimistic. Default, in conjunction with this reÞnement, opens the door to a theory of endogenous assets. The market chooses the promises, default penalties, and quantity constraints of actively traded assets.
Rational Exuberance
 Journal of Economic Literature
, 2004
"... Consider the postage stamp. As title to a future good (or, in this case, service) with monetary value, this humble object is essentially the same as a security. Its value, 37 cents, can be identiÞed with the present value of the service (delivery of a letter) to which its owner is entitled. ..."
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Cited by 19 (0 self)
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Consider the postage stamp. As title to a future good (or, in this case, service) with monetary value, this humble object is essentially the same as a security. Its value, 37 cents, can be identiÞed with the present value of the service (delivery of a letter) to which its owner is entitled.
The Paradox Of Asset Pricing
, 2001
"... Modern finance has generated a set of formal models of the workings of financial markets that certainly excel in terms of mathematical elegance. But abstract beauty and logical appeal do not guarantee scientific validity. The illustrious late Richard Feynman, professor of physics at Caltech, made th ..."
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Cited by 18 (2 self)
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Modern finance has generated a set of formal models of the workings of financial markets that certainly excel in terms of mathematical elegance. But abstract beauty and logical appeal do not guarantee scientific validity. The illustrious late Richard Feynman, professor of physics at Caltech, made the same observation when he discussed the derivation of the law of gravitational potential energy from the "axiom" of conservation of energy. (See the above quote.) Fortunately for physicists, there is ample evidence that the law of gravitational potential energy is correct (to a certain degree). In contrast, there appears to be surprisingly little scientific support for even the most widely used financial model, namely, the CAPM. One can sympathize with E. Fama and K. French when they have recently begun to promote a pricing model that is based entirely on statistical regularities, even if it begs the question why it is more successful. To put this di#erently, asset pricing is paradoxical
2005, The role of expectations in economic fluctuations and the efficacy of monetary policy
 Journal of Economic Dynamics and Control
"... We show diverse beliefs is an important propagation mechanism of fluctuations, money non neutrality and efficacy of monetary policy. Since expectations affect demand, our theory shows economic fluctuations are mostly driven by varying demand not supply shocks. Using a competitive model with flexible ..."
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Cited by 14 (6 self)
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We show diverse beliefs is an important propagation mechanism of fluctuations, money non neutrality and efficacy of monetary policy. Since expectations affect demand, our theory shows economic fluctuations are mostly driven by varying demand not supply shocks. Using a competitive model with flexible prices in which agents hold Rational Belief (see Kurz (1994)) we show that (i) our economy replicates well the empirical record of fluctuations in the U.S. (ii) Under monetary rules without discretion, monetary policy has a strong stabilization effect and an aggressive antiinflationary policy can reduce inflation volatility to zero. (iii) The statistical Phillips Curve changes substantially with policy instruments and activist policy rules render it vertical. (iv) Although prices are flexible, money shocks result in less than proportional changes in inflation hence the aggregate price level appears “sticky ” with respect to money shocks. (v) Discretion in monetary policy adds a random element to policy and increases volatility. The impact of discretion on the efficacy of policy depends upon the structure of market beliefs about future discretionary decisions. We study two rationalizable beliefs. In one case, market beliefs weaken the effect of policy and in the second, beliefs bolster policy outcomes and discretion could be a desirable attribute of the policy rule. Since the central bank does not know any more than the private sector, real social gain from discretion arise only in extraordinary cases. Hence, the weight of the argument leads us to conclude that bank’s policy should
Imitation and contrarian behavior: hyperbolic bubbles, crashes and chaos, Quantitative Finance
, 2002
"... Imitative and contrarian behaviors are the two typical opposite attitudes of investors in stock markets. We introduce a simple model to investigate their interplay in a stock market where agents can take only two states, bullish or bearish. Each bullish (bearish) agent polls m “friends ” and changes ..."
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Cited by 7 (2 self)
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Imitative and contrarian behaviors are the two typical opposite attitudes of investors in stock markets. We introduce a simple model to investigate their interplay in a stock market where agents can take only two states, bullish or bearish. Each bullish (bearish) agent polls m “friends ” and changes her opinion to bearish (bullish) if (1) at least mρhb (mρbh) among the m agents inspected are bearish (bullish) or (2) at least mρhh> mρhb (mρbb> mρbh) among the m agents inspected are bullish (bearish). The condition (1) (resp. (2)) corresponds to imitative (resp. antagonistic) behavior. In the limit where the number N of agents is infinite, the dynamics of the fraction of bullish agents is deterministic and exhibits chaotic behavior in a significant domain of the parameter space {ρhb, ρbh, ρhh, ρbb, m}. A typical chaotic trajectory is characterized by intermittent phases of chaos, quasiperiodic behavior and superexponentially growing bubbles followed by crashes. A typical bubble starts initially by growing at an exponential rate and then crosses over to a nonlinear power law growth rate leading to a finitetime singularity. The reinjection mechanism provided by the contrarian behavior introduces a finitesize effect, rounding off these singularities and leads to chaos. We document the main stylized facts of this model in the symmetric and asymmetric cases. This model is one of the rare agentbased models that give