Macroeconomic Foundations for Discontinuous Price Movements

This paper develops a dynamic general equilibrium asset pricing model to account for the discontinuous price movements commonly observed in the financial markets. We consider two possible sources: (1) jumps in the fundamental economy, as captured by the production technology, and (2) jumps in investors' perception of the economic risk, as captured by the intensity of jumps in the production process. The paper solves the dynamic portfolio decision problem and obtains in analytical forms the general equilibrium pricing of interest rates, bonds, and stocks. We also calibrate the model to the U.S. economy