Replicating Business Cycles and Asset Returns with Sentiment and Low Risk Aversion

Kevin Lansing

No 2021-02, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: I solve for the sequences of shocks (or wedges) that allow a standard real business cycle model to exactly replicate the quarterly time paths of U.S. macroeconomic variables and asset returns since 1960. The resulting shock sequences can be grouped into three main categories: (1) shocks that affect household sentiment and preferences, (2) shocks that appear in the law of motion for capital, and (3) shocks that appear in the production function for output. For most variables including output, no single shock category is clearly dominant in explaining the observed movements in U.S. data. While some variables are driven by a single dominant shock category, the dominant category is different for each of those variables. The results imply that there is no “most important shock.” Rather, U.S. economic outcomes have been shaped by a complex and time-varying mixture of fundamental and non-fundamental disturbances.

Keywords: Belief-driven business cycles; Sentiment; Animal spirits; Risk aversion; Equity risk premium; Bond term premium (search for similar items in EconPapers)
JEL-codes: E32 E44 O41 (search for similar items in EconPapers)
Pages: 54
Date: 2024-07-25
New Economics Papers: this item is included in nep-cwa, nep-dge, nep-mac, nep-ore and nep-upt
Note: Original publication date: 2/8/2021. First revised publication date: 3/1/2023.
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Journal Article: Replicating business cycles and asset returns with sentiment and low risk aversion (2024)
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DOI: 10.24148/wp2021-02

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