A Behavioral Foundation for the Investment Wedge

Jean-Paul L'Huillier, Pierlauro Lopez and Sanjay R. Singh

No 26-30, Working Papers from Federal Reserve Bank of Cleveland

Abstract: Motivated by behavioral evidence, we develop a tractable method for incorporating competition neglect into a general equilibrium firm investment problem. Competition neglect causes firms to systematically underestimate the investment of their competitors. When we introduce competition neglect into a canonical RBC model, this friction acts like an investment wedge that causes over-investment at first, and under-investment later on. In contrast to a model with exogenous investment shocks, these dynamics are accompanied by a realistic variation in equity premia, even in the absence of financial frictions. Investment booms raise stock prices in general equilibrium, predicting periods of low excess returns going forward. The model can generate realistic comovement of real and financial variables.

Keywords: animal spirits; boom-bust cycles; behavioral macroeconomics (search for similar items in EconPapers)
JEL-codes: D21 D91 E22 E32 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2026-10-13
New Economics Papers: this item is included in nep-dge
References: Add references at CitEc
Citations:

Downloads: (external link)
https://doi.org/10.26509/frbc-wp-202630 Persistent link (text/html)
https://www.clevelandfed.org/-/media/project/cleve ... pers/2026/wp2630.pdf Full text (application/pdf)

Related works:
Working Paper: A Behavioral Foundation for the Investment Wedge (2025)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedcwq:103974

Ordering information: This working paper can be ordered from

DOI: 10.26509/frbc-wp-202630

Access Statistics for this paper

More papers in Working Papers from Federal Reserve Bank of Cleveland Contact information at EDIRC.
Bibliographic data for series maintained by 4D Library ().