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Speculation-driven Business Cycles

Author

Listed:
  • Saki Bigio

    (Department of Economics, UCLA; NBER)

  • Eduardo Zilberman

    (Department of Economics, PUC-Rio; Research Department, Central Bank of Chile)

Abstract

Speculation, in the spirit of Harrison and Kreps (1978), is introduced into a standard real business cycle model. Investors (speculators) hold heterogeneous beliefs about firm growth. Firm ownership, and thus, the firm’s discount factor varies with waves of optimism and leverage. These waves ripple into firm investments in hours. The firm’s discount factor links the equity premium and labor volatility puzzles. We obtain an upper bound to the amplification that can be generated by speculation for any model of beliefs—a factor of 1.5. A calibration based on diagnostic beliefs amplifies hours volatility by a factor of 1.15 and produces a bubble component of 20 percent.

Suggested Citation

  • Saki Bigio & Eduardo Zilberman, 2020. "Speculation-driven Business Cycles," Working Papers 161, Peruvian Economic Association.
    • Handle: RePEc:apc:wpaper:161
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    More about this item

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E71 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on the Macro Economy
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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