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Market-Based Solutions to Vital Economic Issues


Kenan Institute 2023 Grand Challenge: Workforce Disrupted
Market-Based Solutions to Vital Economic Issues
Aug 1, 2022

Trendy Business Cycles and Asset Prices


The data-generating process of productivity growth includes both trend and business-cycle shocks, generating many counterfactuals for prices under full-information. In practice, agents cannot immediately distinguish between the two shocks, leading to “rational confusion”: each shock inherits properties of its counterpart. This confusion magnifies the perceived share of permanent shocks and implies that, in contrast to canonical frameworks, transitory shocks are the main driver of long-run risk through trendy business-cycles. With learning, the equity premium turns positive, and both investment and valuation ratios become procyclical, in-line with the data. Consequently, rational confusion is key for bridging disciplined macro-dynamics with equilibrium asset-prices.

Note: Research papers posted on SSRN, including any findings, may differ from the final version chosen for publication in academic journals.   

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