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A Bayesian DSGE Model of Stock Market Bubbles and Business Cycles

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  • Zhiwei Xu

    (Hong Kong University of Science and Technology)

  • Pengfei Wang

    (Hong Kong University of Science and Tech)

  • Jianjun Miao

    (Boston University)

Abstract

We present an estimated DSGE model of stock market bubbles and business cycles using Bayesian methods. Bubbles emerge through a positive feedback loop mechanism supported by self-fulfilling beliefs. We identify a sentiment shock which drives the movements of bubbles and is transmitted to the real economy through endogenous credit constraints. This shock explains more than 96 percent of the stock market volatility and about 25 to 45 percent of the variations in investment and output. It generates the comovements between stock prices and macroeconomic quantities and is the dominant force in driving the internet bubbles and the Great Recession.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 167.

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Date of creation: 2013
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Handle: RePEc:red:sed013:167

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Cited by:
  1. Luik, Marc-André & Wesselbaum, Dennis, 2014. "Bubbles over the U.S. business cycle: A macroeconometric approach," Journal of Macroeconomics, Elsevier, vol. 40(C), pages 27-41.

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