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“Aggregate Investment and Stock Returns”
ByF.Duarte , L. Kogan and D. Livdan
Discussion
By
D.P.Tsomocos
3rd International Moscow Finance Conference
November 8-9,2013
Moscow
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Summary I
• A canonical real business cycle model with preference shocks to the representative household
− time varying beliefs w.r.t. pessimism or optimism (cf habit formation)
→ variation of risk prices
• Inverse relation between investment and future excess returns
− lower discount rates → higher NPVs of investments → increased aggrregatet investment
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Summary II
• Positive relation between investment and future stock market volatility
− Elementary stock valuation implies that lower discount rates for given dividend rules increase equity prices. The lower the difference between discount and growth rates the higher the impact on prices.
− since lower discount rates lead to higher investment → time varying discount rates generate positively related investment and stock market volatility.
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Summary III
• A general equilibrium formulation of a stock market negative mean-variance trade off, ceteris paribus, generated by time varying discount rates.
• Perturbations of production functions and preferences determine the variability of discount rates.
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Comments I
•Real changes cause real effects → emphasis on prices rather than on quantities:
→ Δ M • V = Δ P • Q̅,
•Debreu-Mantel-Sonnenshein Theorem: − “Any aggregate excess demand can be generated by
a reasonable economy”.
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Comments II
•Incomplete asset markets
−Precautionary motive causes higher equity premia (Weil, 1982)
•Liquidity constraints and premia
−Liquidity shortages generate higher state prices and, thus, decrease investment (Goodhart, Espinoza and Tsomocos, 2009)
•Modigliani-Miller − Endogenous default and limited liability (Kashyap, Tsomocos and Vardoulakis, 2013)
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THANK YOU!