Asset Prices in a News Driven Real Business Cycle Model

We examine,the implications of introducing,anticipated productivity,shocks for the ability of a real-business-cycle model,to explain asset prices. Our theoretical framework,is a real-business-cycle model,in which agents receive news about future productivity shocks. We show that incorporating anticipated shocks, or news, cre- ates a persistent predictable component in consumption growth, often referred to as long-run risk in the …nance literature (Bansal and Yaron, 2004). Thus, in con- junction with Epstein and Zin (1989) preferences and under,plausible parameter calibrations, news shocks help explain key observed asset pricing facts. Further- more, we show that news shocks improve our prediction for the co-movement of macroeconomic and …nancial variables, and explain the asset returns’lead over the business cycle. We also model,time-varying economic,uncertainty,(stochastic volatility), and show how under certain conditions this could lead to lower premia in a model where consumption is endogenous. Finally, we discuss how a class of dynamic,stochastic general equilibrium,models,with recursive preferences can be solved using perturbation methods, which are more computationally e¢ cient than the usual numerical,techniques. Keywords : Anticipated Shocks, Long-Run Risk, Stochastic Volatility, Asset Prices and Aggregate Fluctuations, Perturbation Methods and Recursive Prefer- ences JEL Classi…cation : G12, E32, E21, C63 We thank Kosuke Aoki, Mikhail Chernov, Francois Gourio, Stephanie Schmitt-Grohe, Wouter den