Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/88720
Authors: 
Branger, Nicole
Grüning, Patrick
Kraft, Holger
Meinerding, Christoph
Year of Publication: 
2013
Series/Report no.: 
SAFE Working Paper Series 34
Abstract: 
We analyze the equilibrium in a two-tree (sector) economy with two regimes. The output of each tree is driven by a jump-diffusion process, and a downward jump in one sector of the economy can (but need not) trigger a shift to a regime where the likelihood of future jumps is generally higher. Furthermore, the true regime is unobservable, so that the representative Epstein-Zin investor has to extract the probability of being in a certain regime from the data. These two channels help us to match the stylized facts of countercyclical and excessive return volatilities and correlations between sectors. Moreover, the model reproduces the predictability of stock returns in the data without generating consumption growth predictability. The uncertainty about the state also reduces the slope of the term structure of equity. We document that heterogeneity between the two sectors with respect to shock propagation risk can lead to highly persistent aggregate price-dividend ratios. Finally, the possibility of jumps in one sector triggering higher overall jump probabilities boosts jump risk premia while uncertainty about the regime is the reason for sizeable diffusive risk premia.
Subjects: 
General Equilibrium
Contagion Risk
Partial Information
Filtering
Recursive Utility
JEL: 
G01
G12
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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