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Sentiments, Financial Markets, and Macroeconomic Fluctuations

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

No 21294, NBER Working Papers from National Bureau of Economic Research, Inc

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 non-linear asset prices and for economic contagion and co-movement across countries. In the extension to the dynamic OLG setting, our model demonstrates that sentiment shocks can generate persistent output, employment and business cycle fluctuations, and offers some new implications for asset prices over business cycles.

JEL-codes: E02 E44 G01 G20 (search for similar items in EconPapers)
Date: 2015-06
New Economics Papers: this item is included in nep-dge and nep-mac
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Published as Benhabib, Jess & Liu, Xuewen & Wang, Pengfei, 2016. "Sentiments, financial markets, and macroeconomic fluctuations," Journal of Financial Economics, Elsevier, vol. 120(2), pages 420-443.

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