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Behavioral Theories of the Business Cycle

Author

Listed:
  • Nir Jaimovich

    (Department of Economics, Stanford University)

  • Sergio Rebelo

    (Northwestern University)

Abstract
We explore the business cycle implications of expectation shocks and of two well-known psychological biases, optimism and overconfidence. The expectations of optimistic agents are biased toward good outcomes, while overconfident agents overestimate the precision of the signals that they receive. Both expectation shocks and overconfidence can increase business-cycle volatility, while preserving the model's properties in terms of comovement, and relative volatilities. In contrast, optimism is not a useful source of volatility in our model.

Suggested Citation

  • Nir Jaimovich & Sergio Rebelo, 2006. "Behavioral Theories of the Business Cycle," Discussion Papers 07-015, Stanford Institute for Economic Policy Research.
    • Handle: RePEc:sip:dpaper:07-015
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Steinar Holden, 2012. "Implications of insights from behavioral economics for macroeconomic models," Working Paper 2012/12, Norges Bank.
    2. Carlos Garcia & Andrés Sagner, 2012. "Exceso de Toma de Riesgo Crediticio en Chile," ILADES-UAH Working Papers inv280, Universidad Alberto Hurtado/School of Economics and Business.
    3. Bachmann, Rüdiger & Elstner, Steffen, 2015. "Firm optimism and pessimism," European Economic Review, Elsevier, vol. 79(C), pages 297-325.
    4. Dave, Chetan & Malik, Samreen, 2017. "A tale of fat tails," European Economic Review, Elsevier, vol. 100(C), pages 293-317.
    5. Maurizio Bovi, 2016. "The tale of two expectations," Quality & Quantity: International Journal of Methodology, Springer, vol. 50(6), pages 2677-2705, November.
    6. Olkhov, Victor, 2018. "Economic and Financial Transactions Govern Business Cycles," MPRA Paper 93269, University Library of Munich, Germany.
    7. Evgeniy Kutsenko & Ekaterina Islankina & Alexey Kindras, 2018. "Smart by Oneself? An Analysis of Russian Regional Innovation Strategies within the RIS3 Framework," Foresight and STI Governance (Foresight-Russia till No. 3/2015), National Research University Higher School of Economics, vol. 12(1), pages 25-45.
    8. Nielsen, Carsten Krabbe, 2015. "The loan contract with costly state verification and subjective beliefs," Mathematical Social Sciences, Elsevier, vol. 78(C), pages 89-105.
    9. Argentiero, Amedeo & Bovi, Maurizio & Cerqueti, Roy, 2015. "Over consumption. A horse race of Bayesian DSGE models," MPRA Paper 66445, University Library of Munich, Germany.
    10. Driscoll, John C. & Holden, Steinar, 2014. "Behavioral economics and macroeconomic models," Journal of Macroeconomics, Elsevier, vol. 41(C), pages 133-147.
    11. Olkhov, Victor, 2018. "Economic Transactions Govern Business Cycles," MPRA Paper 87207, University Library of Munich, Germany.
    12. Suda, J., 2013. "Belief shocks and the macroeconomy," Working papers 434, Banque de France.
    13. Yuriy Bilan & Maryna Brychko & Anna Buriak & Tetyana Vasilyeva, 2019. "Financial, business and trust cycles: the issues of synchronization," Zbornik radova Ekonomskog fakulteta u Rijeci/Proceedings of Rijeka Faculty of Economics, University of Rijeka, Faculty of Economics and Business, vol. 37(1), pages 113-138.
    14. Abildgren, Kim & Hansen, Niels Lynggård & Kuchler, Andreas, 2018. "Overoptimism and house price bubbles," Journal of Macroeconomics, Elsevier, vol. 56(C), pages 1-14.
    15. Carlos Garcia & Andrés Sagner, 2011. "Crédito, Exceso de Toma de Riesgo, Costo del Crédito y Ciclo Económico en Chile," ILADES-UAH Working Papers inv271, Universidad Alberto Hurtado/School of Economics and Business.
    16. Ioan Roxana, 2015. "The Influence Of Stock Market Investors’ Behavior On Business Cycles," Annals - Economy Series, Constantin Brancusi University, Faculty of Economics, vol. 6, pages 136-144, December.
    17. Sylvain Leduc, 2010. "Confidence and the business cycle," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue nov22.
    18. Geetika Madaan & Sanjeet Singh, 2019. "An Analysis of Behavioral Biases in Investment Decision-Making," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 10(4), pages 55-67, July.
    19. Lennart Erixon & Louise Johannesson, 2015. "Is the psychology of high profits detrimental to industrial renewal? Experimental evidence for the theory of transformation pressure," Journal of Evolutionary Economics, Springer, vol. 25(2), pages 475-511, April.
    20. Kevin J. Lansing, 2008. "Speculative growth and overreaction to technology shocks," Working Paper Series 2008-08, Federal Reserve Bank of San Francisco.
    21. Ma, Xiaohan & Samaniego, Roberto, 2022. "Business cycle dynamics when neutral and investment-specific technology shocks are imperfectly observable," Journal of Mathematical Economics, Elsevier, vol. 101(C).
    22. Doshchyn, Artur & Giommetti, Nicola, 2013. "Learning, Expectations, and Endogenous Business Cycles," MPRA Paper 49617, University Library of Munich, Germany.
    23. Dmitriev, Mikhail, 2009. "Confidence of Agents and Market Frictions," MPRA Paper 21149, University Library of Munich, Germany.

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    More about this item

    Keywords

    business cycle; optimism; overconfidence; volatility;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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