Equilibrium prices under hidden Markov fundamentals
Abstract
We study a representative-agent Epstein-Zin economy with geometric dividends and a hidden finite-state Markov drift. We allow the price-dividend ratio to contain an additional positive, absolutely continuous valuation factor and, within the class C defined below and under the regularity, admissibility, and positivity conditions of our main theorem, equilibrium forces this factor to be constant, yielding belief-Markovian prices. In the two-state case, under the stated positivity condition and strictly positive transition intensities, we prove existence, uniqueness, endpoint smoothness, interior analyticity, and uniform bounds for the positive solution of the pricing equation. For 0<θ≤1, this solution supports an equilibrium under any continuous short rate satisfying the model's one-sided portfolio condition. Finally, in the two-state subregion η>0, we derive belief-dependent stock volatility, a European option-pricing PDE, and a leading short-maturity conditional risk-neutral log-return skewness expansion.
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BibTeX
@misc{pages2026equilibrium,
title = {{Equilibrium prices under hidden Markov fundamentals}},
author = {Henri Pagès and Dylan Possamaï and Mateo Rodriguez Polo},
howpublished = {arXiv},
year = {2026},
month = sep,
doi = {10.48550/arxiv.2609.21684},
eprint = {2609.21684},
archivePrefix = {arXiv},
url = {https://arxiv.org/abs/2609.21684},
}
RIS
TY - UNPB
TI - Equilibrium prices under hidden Markov fundamentals
AU - Henri Pagès
AU - Dylan Possamaï
AU - Mateo Rodriguez Polo
PY - 2026
DA - 2026/09/18
PB - arXiv
DO - 10.48550/arxiv.2609.21684
UR - https://arxiv.org/abs/2609.21684
AB - We study a representative-agent Epstein-Zin economy with geometric dividends and a hidden finite-state Markov drift. We allow the price-dividend ratio to contain an additional positive, absolutely continuous valuation factor and, within the class C defined below and under the regularity, admissibility, and positivity conditions of our main theorem, equilibrium forces this factor to be constant, yielding belief-Markovian prices. In the two-state case, under the stated positivity condition and strictly positive transition intensities, we prove existence, uniqueness, endpoint smoothness, interior analyticity, and uniform bounds for the positive solution of the pricing equation. For 0<θ≤1, this solution supports an equilibrium under any continuous short rate satisfying the model's one-sided portfolio condition. Finally, in the two-state subregion η>0, we derive belief-dependent stock volatility, a European option-pricing PDE, and a leading short-maturity conditional risk-neutral log-return skewness expansion.
ER -