Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/102369
Authors: 
Liu, Hening
Year of Publication: 
2011
Series/Report no.: 
Manchester Business School Working Paper 620
Abstract: 
I develop a stochastic growth model with production where there is a hidden state governing productivity growth regimes, and the hidden state evolves according to a Markov chain. Economic agents learn about the hidden state and display ambiguity aversion in the spirit of Klibanoff et al. (2005). I calibrate the model to the post-war US data. The main findings are (1) the model can generate a high and volatile equity premium while a low and smooth risk-free rate, (2) agents' fluctuating beliefs induce countercylical variation in equity premium and in the expected volatility of returns, and moreover volatility clusterng and persistence; and (3) Bayesian learning itself is unable to generate a significant and positive risk premium once time variation in investment opportunities is accounted for; in most cases, Bayesian learning lowers the unconditional mean of equity premium.
Subjects: 
Countercylical
Equity premium
Markov switching
Smooth ambiguity
Stochastic growth
JEL: 
C61
D81
G11
G12
Document Type: 
Working Paper

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