The Macroeconomics of Financial Speculation

Alp Simsek ()
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Alp Simsek: Department of Economics, Massachusetts Institute of Technology, Cambridge, Massachusetts 02142, USA

Annual Review of Economics, 2021, vol. 13, issue 1, 335-369

Abstract: I review the literature on financial speculation driven by belief disagreements from a macroeconomics perspective. To highlight unifying themes, I develop a stylized macroeconomic model that embeds several mechanisms. With short-selling constraints, speculation can generate overvaluation and speculative bubbles. Leverage can substantially inflate speculative bubbles, and leverage limits depend on perceived downside risks. Shifts in beliefs about downside tail scenarios can explain the emergence and the collapse of leveraged speculative bubbles. Speculative bubbles are related to rational bubbles, but they match better the empirical evidence on the predictability of asset returns. Even without short-selling constraints, speculation induces procyclical asset valuation. When speculation affects the price of aggregate assets, it also influences macroeconomic outcomes such as aggregate consumption, investment, and output. Speculation in the boom years reduces asset prices, aggregate demand, and output in the subsequent recession. Macroprudential policies that restrict speculation in the boom can improve macroeconomic stability and social welfare.

Keywords: financial speculation; belief disagreements; short selling; leverage; speculative bubbles; rational bubbles; countercyclical risk premium; business cycles; aggregate demand recessions; macroprudential policy (search for similar items in EconPapers)
JEL-codes: E00 E12 E21 E22 E32 E44 E52 E70 G00 G01 G11 G12 G40 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (11)

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DOI: 10.1146/annurev-economics-092120-050543

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