Comment on "The Spirit of Capitalism and Stock Market Prices" By G.S. Bakshi and Z. Chen (AER, 1996)

share prices;capitalism;financial markets

Can Habit Formation be Reconciled with Business Cycle Facts?

Many asset pricing puzzles can be explained when habit formation is added to standard preferences. We show that utility functions with a habit then gives rise to a puzzle of consumption volatility in place of the asset pricing puzzles when agents can choose consumption and labor optimally in response to more fundamental shocks. We show that the consumption reaction to technology shocks are too small by an order of magnitude when a utility includes a habit. Alternative models with consistent and exogenous but stochastic labor input are considered. A model with persistent technology shocks and stochastic labor is shown to be potentially consistent with substantial consumption variability aswell as procyclical labor input and labor productivity even when a habit is present.

Rule of Thumb and Dynamic Programming

This paper studies the relationships between learning about rules of thumb (represented by classifier systems) and dynamic programming. Building on a result about Markovian stochastic approximation algorithms, we characterize all decision functions that can be asymptotically obtained through classifier system learning, provided the asymptotic ordering of the classifiers is strict. We demonstrate in a robust example that the learnable decision function is in general not unique, not characterized by a strict ordering of the classifiers, and may not coincide with the decision function delivered by the solution to the dynamic programming problem even if that function is attainable. As an illustration we consider the puzzle of excess sensitivity of consumption to transitory income: classifier systems can generate such behavior even if one of the available rules of thumb is the decision function solving the dynamic programming problem, since bad decisions in good times can "feel better" than good decisions in bad times.

Robustness of adaptive expectations as an equilibrium selection device

Equilibrium Theory;Rational Expectations

Pitfalls in the theory of carrier dynamics in semiconductor quantum dots: the single-particle basis vs. the many-particle configuration basis

We analyze quantum dot models used in current research for misconceptions that arise from the choice of basis states for the carriers. The examined models originate from semiconductor quantum optics, but the illustrated conceptional problems are not limited to this field. We demonstrate how the choice of basis states can imply a factorization scheme that leads to an artificial dependency between two, actually independent, quantities. Furthermore, we consider an open quantum dot-cavity system and show how the dephasing, generated by the dissipator in the von Neumann Lindblad equation, depends on the choice of basis states that are used to construct the collapse operators. We find that the Rabi oscillations of the s-shell exciton are either dephased by the dissipative decay of the p-shell exciton or remain unaffected, depending on the choice of basis states. In a last step we resolve this discrepancy by taking the full system-reservoir interaction Hamiltonian into account

Investor Information, Long-Run Risk, and the Term Structure of Equity

We study the role of information in asset pricing models with long-run cash flow risk. When investors can distinguish short- from long-run consumption risks (full information), the model generates a sizable equity risk premium only if the equity term structure slopes up, contrary to the data. In general, the short- and long-run components are unidentified. We propose a sparsity-based bounded rationality model of long-run risk that is both parsimonious and fully identified from historical data. In contrast to full information, the model generates a sizable market risk premium simultaneously with a downward sloping equity term structure, as in the data.

Investor Information, Long-Run Risk, and the Duration of Risky Cash Flows

We study the role of information in asset pricing models with long-run cash ow risk. To illustrate the importance of the information structure, we show how the implications of the long run risk paradigm for the cross-sectional properties of stock returns and cash flow duration are affected by information. When investors can fully distinguish short and long-run consumption risk components of dividend growth innovations (full information), only exposure to long-run consumption risk generates significant risk premia, implying that high return value stocks are long-duration assets, contrary to the historical data. By contrast,when investors observe the change in consumption and dividends each period but not the individual components of that change (limited information), exposure to short-run risk can generate large risk premia, so that high-return value stocks are short-duration assets while low-return growth stocks are long-duration assets, as in the data. We also show that, in order to explain empirical finding that long-horizon equity is less risky than short-horizon equity, the properties of the cash ow model and the values of primitive preference parameters must be quite different from those emphasized in the existing long-run risk literature