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Uncertainty in financial markets and business cycles

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  • Yıldırım-Karaman, Seçil

Abstract

Can financial uncertainty shocks induce real downturns? To investigate this question theoretically, this paper develops a dynamic stochastic general equilibrium model with two period lived heterogenous agents, monopolistically competitive firms and sticky prices. In the model financial uncertainty is measured by the volatility of stock prices and this volatility results from the stochastic irrational beliefs of nonsophisticated agents about the future performance of the stock. An increase in the stock price volatility decreases aggregate demand and generates a significant contraction in output. The model contributes to the literature by modeling financial market volatility in a general equilibrium framework, establishing its causal impact on real variables, highlighting the mechanisms through which the impact works, and providing estimates of its magnitude.

Suggested Citation

  • Yıldırım-Karaman, Seçil, 2018. "Uncertainty in financial markets and business cycles," Economic Modelling, Elsevier, vol. 68(C), pages 329-339.
    • Handle: RePEc:eee:ecmode:v:68:y:2018:i:c:p:329-339
    DOI: 10.1016/j.econmod.2017.08.001
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    2. Fan He & Xuansen He, 2019. "A Continuous Differentiable Wavelet Shrinkage Function for Economic Data Denoising," Computational Economics, Springer;Society for Computational Economics, vol. 54(2), pages 729-761, August.
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    4. Beirne, John, 2020. "Financial cycles in asset markets and regions," Economic Modelling, Elsevier, vol. 92(C), pages 358-374.

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    More about this item

    Keywords

    Financial uncertainty; Volatility shocks; DSGE; Business cycles; Great recession;
    All these keywords.

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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