Krannert School of Management

This paper addresses the e ects of indeterminacy on the volatility of asset prices in a stochastic overlapping generations model with 3-period lived agents. With complete markets, the only indeterminacy is due to the selection of initial conditions for the economy. As with deterministic economies, the equilibrium set converges to the steady state in the long run. With incomplete markets, not only do the initial conditions introduce indeterminacy, but additionally each period a continuum of state price vectors can be selected as equilibrium continuation values. This additional indeterminacy in each period generates long-run price behavior that depends on both the fundamentals of the economy and the endogenous price expectations of agents. Using our innovative computational methodology, we characterize the entire set of sequential equilibria for an incomplete markets economy. Our numerical simulations suggest that asset price volatility has substantial welfare e ects, persists in the long run, and is primarily driven by the endogenous price expectations of agents and not by endowment risk.