Asset price volatility in a nonconvex general equilibrium model

Asset prices and returns are known to vary signi®cantly more than output or aggregate consumption growth, and an order of magnitude in excess of what is justi®ed by innovations to fundamentals. We study excess price volatility in a lifecycle economy with two assets (claims on capital and a public debt bubble), heterogeneous agents, and increasing returns to ®nancial intermediation. We show that a relatively modest nonconvexity generates a set valued equilibrium correspondence in asset prices, with two stable branches. Price volatility is the outcome of an equilibrium selection mechanism, which mixes adaptive learning with ``noise'', and alternates stochastically between the two stable branches of the price correspondence.