On the Nature and Stability of Sentiments
Gaetano Gaballo () and
No 469, 2015 Meeting Papers from Society for Economic Dynamics
We show that non-trivial aggregate fluctuations may originate with vanishingly-small common shocks to either information or fundamentals. These 'sentiment' fluctuations can be driven by self-fulfilling variation in either first-order beliefs (as in Benhabib et al., 2015) or higher-order beliefs (as in Angeletos and La'O, 2013), due to an endogenous signal structure. We analyze out-of-equilibrium best-response functions in the underlying coordination game to study whether sentiment equilibria are stable outcomes of a convergent process. We find that limiting sentiment equilibria are generally unattainable under both higher-order belief and adaptive learning dynamics, whereas equilibria without sentiment shocks show strong stability properties. Away from the limit case, however, multiple noisy rational expectations equilibria may be stable.
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