On November 16, Ana Fostel came to Rutgers University to present her latest paper entitled “Why does Bad News Increase Volatility and Decrease Leverage?” (co-written with John Geanakoplos).
Building on literature that in order to explain pro-cyclical leverage assumes that bad news increase volatility, the authors try to explain why we should use this assumption.
With this purpose in mind, they built a general equilibrium model with endogenous leverage and agents with heterogeneous beliefs.
They found that in their model, in equilibrium, the agents mostly invest in projects that become volatile with bad news.
The authors get to this conclusion by generalizing the three period economy that they built. However, it is belief that they should also had ran a Markov chain Monte Carlo, in order to provide some evidence for their theoretical results. This could be done as long as we are willing to impose a distribution on the utility and endowment of the agents. With this we could check if the results of the model resemble the data that is presented in the paper.