follows Suppose stock price P, is related to dividend D, as EPt+1 + Dt R where...

 

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follows Suppose stock price P, is related to dividend D, as E₁Pt+1 + Dt R where R is a constant discount rate that is larger than 1. The dividend process is AR(1), D₁ = pDt-1 + et where -1 < p < 1 and ę, is random shock with mean zero and uncorrelated over time. P₁ = Pt a) Solve for the stock price P, under rational expectations using any method you want. (Hint: the solution for P, has the form of constant x D) b) It turns out that there is also a "bubble" solution, where the solution is simply the P, you have just solved for in a) plus a "bubble" term B₁. Explain why we need the condition Et Bt+1 = RBt for the "bubble" solution to work. c) To eliminate the "bubble", we need the assumption that R-TEP+7 goes to zero when T goes to infinity. Explain why the assumption can eliminate the "bubble". follows Suppose stock price P, is related to dividend D, as E₁Pt+1 + Dt R where R is a constant discount rate that is larger than 1. The dividend process is AR(1), D₁ = pDt-1 + et where -1 < p < 1 and ę, is random shock with mean zero and uncorrelated over time. P₁ = Pt a) Solve for the stock price P, under rational expectations using any method you want. (Hint: the solution for P, has the form of constant x D) b) It turns out that there is also a "bubble" solution, where the solution is simply the P, you have just solved for in a) plus a "bubble" term B₁. Explain why we need the condition Et Bt+1 = RBt for the "bubble" solution to work. c) To eliminate the "bubble", we need the assumption that R-TEP+7 goes to zero when T goes to infinity. Explain why the assumption can eliminate the "bubble".

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a To solve for the stock price P under rational expectations we use the rational expectations hypothesis which assumes that agents expectations are un... View the full answer