Macroeconomic and Stock Market Interactions with Endogenous Aggregate Sentiment Dynamics

Flaschel, Peter; Charpe, Matthieu; Galanis, Giorgos; Proano, Christian and Veneziani, Roberto. 2018. Macroeconomic and Stock Market Interactions with Endogenous Aggregate Sentiment Dynamics. Journal of Economic Dynamics and Control, 91, pp. 237-256. ISSN 0165-1889 [Article]

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Abstract or Description

This paper studies the implications of heterogeneous capital gain expectations on output and asset prices. We consider a disequilibrium macroeconomic model where agents' expectations on future capital gains affect aggregate demand. Agents' beliefs take two forms -- fundamentalist and chartist -- and the relative weight of the two types of agents is endogenously determined. We show that there are two sources of instability arising from the interaction of the financial with the real part of the economy, and from the heterogeneous opinion dynamics. Two main conclusions are derived. On the one hand, perhaps surprisingly, the non-linearity embedded in the opinion dynamics far from the steady state can play a stabilizing role by preventing the economy from moving towards an explosive path. On the other hand, however, real-financial interactions and sentiment dynamics do amplify exogenous shocks and tend to generate persistent fluctuations and the associated welfare losses. We consider alternative policies to mitigate these effects.

Item Type:

Article

Identification Number (DOI):

https://doi.org/10.1016/j.jedc.2017.10.002

Keywords:

Real-financial interactions, Heterogeneous expectations, Aggregate sentiment dynamics, Macro-financial instability

Departments, Centres and Research Units:

Institute of Management Studies

Dates:

DateEvent
7 October 2017Accepted
14 October 2017Published Online
June 2018Published

Item ID:

22018

Date Deposited:

17 Nov 2017 16:37

Last Modified:

09 Jun 2021 12:39

Peer Reviewed:

Yes, this version has been peer-reviewed.

URI:

https://research.gold.ac.uk/id/eprint/22018

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