This study documents how investors extrapolate from recent stock returns of locally headquartered firms when forming beliefs about aggregate stock market outcomes. Consistent with studies on the equity home bias, we find that the responsiveness to local information is a function of proximity. While investors may feel more comfortable interpreting local information, we find no evidence that these effects are sensitive to the informativeness of local returns for the aggregate outcome. Our findings suggest that differences in beliefs about information contained in public signals varies systematically with geography, which has been suggested as an important driver of the local bias in equity markets.

We study a macro-finance model with entrepreneurs who have diverse views about the likelihood that their ideas will lead to successful innovations. These views and the resulting experimentation stimulate economic growth and overcome market failures that would otherwise occur in an equilibrium without this diversity. The resulting benefits for future generations come at the cost of higher wealth and consumption inequality because a few entrepreneurs will ex-post be successful while most entrepreneurs will fail. Hence, our model provides a potential explanation for the “entrepreneurial puzzle” in which entrepreneurs choose to innovate despite taking on substantial idiosyncratic risk accompanied by low expected returns. Venture capital funds and taxes enhance risk sharing among entrepreneurs, stimulating innovation and growth unless high taxes deplete entrepreneurial capital. Redistribution via taxes reduces inequality and can raise interest rates. Nevertheless, a tradeoff exists between risk-sharing and the exertion of costly effort, giving rise to a hump-shaped economic growth curve when plotted against tax rates.

Recent findings on the term structure of equity and bond yields pose severe challenges to existing equilibrium asset pricing models. This paper presents a new equilibrium model of subjective expectations to explain the joint historical dynamics of equity and bond yields (and their yield spreads). Equity/bond yields movements are mainly driven by subjective dividend/GDP growth expectations. Yields on short-term dividend claims are more volatile because short-term dividend growth expectation mean-reverts to its less volatile long-run counterpart. Procyclical slope of equity yields is due to the counter-cyclical slope of dividend growth expectations. The correlation between equity returns/yields and nominal bond returns/yields switched from positive to negative after the late 1990s, mainly owing to a shift in correlation between real GDP growth and real dividend growth expectations from negative to positive, and only partially due to procyclical inflation. Dividend strip returns are predictable and the strength of predictability decreases with maturity due to underreaction to dividend news and hence predictable dividend forecast revisions. The model is also consistent with the data in generating persistent and volatile price-dividend ratios, excess return volatility, and momentum.