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Sentiments, financial markets, and macroeconomic fluctuations

Jess Benhabib (), Xuewen Liu and Pengfei Wang ()

Journal of Financial Economics, 2016, vol. 120, issue 2, 420-443

Abstract: This paper studies how financial information frictions can generate sentiment-driven fluctuations in asset prices and self-fulfilling business cycles. In our model economy, exuberant financial market sentiments of high output and high demand for capital increase the price of capital, which signals strong fundamentals of the economy to the real side and consequently leads to an actual boom in real output and employment. The model further derives implications for asymmetric nonlinear asset prices and for economic contagion and co-movement across countries. In the extension to the dynamic overlapping generations (OLG) setting, our model demonstrates that sentiment shocks can generate persistent output, employment, and business cycle fluctuations, and it offers some new implications for asset prices over business cycles.

Keywords: Financial sector; Sentiment-driven fluctuations; Self-fulfilling business cycles; Beauty contests; Animal spirits (search for similar items in EconPapers)
JEL-codes: E2 E44 G01 G20 (search for similar items in EconPapers)
Date: 2016
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Working Paper: Sentiments, Financial Markets, and Macroeconomic Fluctuations (2015) Downloads
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DOI: 10.1016/j.jfineco.2016.01.008

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