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The Anatomy of Sentiment-Driven Fluctuations

Sushant Acharya (), Jess Benhabib () and Zhen Huo

Staff Working Papers from Bank of Canada

Abstract: We show that sentiments—self-fulfilling changes in beliefs that are orthogonal to fundamentals—can drive persistent aggregate fluctuations under rational expectations in a beauty contest game. Such fluctuations can occur even in the absence of exogenous aggregate fundamental shocks. Moreover, sentiments alter the volatility and persistence of aggregate outcomes in response to fundamental shocks. We provide (i) necessary conditions under which sentiments can affect aggregate outcomes in equilibrium and (ii) conditions under which sentiments drive persistent fluctuations and when they only affect aggregate outcomes contemporaneously. We also show that sentiment equilibria are stable under least-squares learning while the fundamental equilibrium is not.

Keywords: Business fluctuations and cycles; Economic models (search for similar items in EconPapers)
JEL-codes: E20 E32 F44 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2021-07
New Economics Papers: this item is included in nep-mac, nep-opm and nep-ore
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Related works:
Journal Article: The anatomy of sentiment-driven fluctuations (2021) Downloads
Working Paper: The Anatomy of Sentiment-Driven Fluctuations (2017) Downloads
Working Paper: The Anatomy of Sentiment-driven Fluctuations (2017) Downloads
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