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Financial Markets, the Real Economy, and Self‐Fulfilling Uncertainties

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  • JESS BENHABIB
  • XUEWEN LIU
  • PENGFEI WANG

Abstract

We develop a model of informational interdependence between financial markets and the real economy, linking economic uncertainty to information production and aggregate economic activities in general equilibrium. The mutual learning between financial markets and the real economy creates a strategic complementarity in their information production, leading to self‐fulfilling surges in economic uncertainties. In a dynamic setting, our model characterizes self‐fulfilling uncertainty traps with two steady‐state equilibria and a two‐stage economic crisis in transitional dynamics.

Suggested Citation

  • Jess Benhabib & Xuewen Liu & Pengfei Wang, 2019. "Financial Markets, the Real Economy, and Self‐Fulfilling Uncertainties," Journal of Finance, American Finance Association, vol. 74(3), pages 1503-1557, June.
  • Handle: RePEc:bla:jfinan:v:74:y:2019:i:3:p:1503-1557
    DOI: 10.1111/jofi.12764
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    Cited by:

    1. Karamysheva, Madina, 2022. "How do fiscal adjustments work? An empirical investigation," Journal of Economic Dynamics and Control, Elsevier, vol. 137(C).
    2. Arnold, Lutz G. & Zelzner, Sebastian, 2022. "Financial trading versus entrepreneurship: Competition for talent and negative feedback effects," The Quarterly Review of Economics and Finance, Elsevier, vol. 86(C), pages 186-199.
    3. Itay Goldstein, 2023. "Information in Financial Markets and Its Real Effects," Review of Finance, European Finance Association, vol. 27(1), pages 1-32.
    4. Xu, Zhiwei & Zhou, Fei & Zhou, Jing, 2022. "Sentiments and real business cycles," Journal of Economic Dynamics and Control, Elsevier, vol. 141(C).
    5. Yang Hao, 2023. "Financial Market with Learning from Price under Knightian Uncertainty," Working Papers hal-03686748, HAL.
    6. Paymon Khorrami & Fernando Mendo, 2021. "Rational Sentiments and Financial Frictions," Working Papers Central Bank of Chile 928, Central Bank of Chile.
    7. Marco Di Maggio & Amir Kermani & Rodney Ramcharan & Vincent Yao & Edison Yu, 2020. "The Pass-Through of Uncertainty Shocks to Households," NBER Working Papers 27646, National Bureau of Economic Research, Inc.
    8. Elder, John, 2020. "Employment and energy uncertainty," The Journal of Economic Asymmetries, Elsevier, vol. 21(C).
    9. Berardi, Michele, 2021. "Uncertainty, sentiments and time-varying risk premia," MPRA Paper 106922, University Library of Munich, Germany.
    10. Elder, John & Payne, James E., 2023. "Racial and ethnic disparities in unemployment and oil price uncertainty," Energy Economics, Elsevier, vol. 119(C).

    More about this item

    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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