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Real business cycles, animal spirits, and stock market valuation

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  • Kevin J. Lansing

Abstract

This paper develops a real business cycle model with five types of fundamental shocks and one “equity sentiment shock” that captures fluctuations driven by animal spirits. The representative agent's perception that movements in equity value are partly driven by sentiment turns out to be close to self‐fulfilling. I solve for the sequences of shock realizations that allow the model to exactly replicate the observed time paths of US consumption, investment, hours worked, the stock of physical capital, capital's share of income, and the S&P 500 market value from 1960.Q1 onwards. The model‐identified sentiment shock is strongly correlated with survey‐based measures of US consumer sentiment. Counterfactual scenarios with the model suggest that the equity sentiment shock has an important influence on the paths of most US macroeconomic variables.

Suggested Citation

  • Kevin J. Lansing, 2019. "Real business cycles, animal spirits, and stock market valuation," International Journal of Economic Theory, The International Society for Economic Theory, vol. 15(1), pages 77-94, March.
    • Handle: RePEc:bla:ijethy:v:15:y:2019:i:1:p:77-94
    DOI: 10.1111/ijet.12204
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    Cited by:

    1. Wei Dai & Mark Weder & Bo Zhang, 2020. "Animal Spirits, Financial Markets, and Aggregate Instability," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(8), pages 2053-2083, December.
    2. Jose E. Gomez-Gonzalez & Jorge Hirs-Garzón & Sebastián Sanín-Restrepo, 2021. "Dynamic relations between oil and stock markets: Volatility spillovers, networks and causality," International Economics, CEPII research center, issue 165, pages 37-50.
    3. Gabrovski, Miroslav & Ortego-Marti, Victor, 2021. "Search and credit frictions in the housing market," European Economic Review, Elsevier, vol. 134(C).
    4. Lansing, Kevin J., 2021. "Endogenous forecast switching near the zero lower bound," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 153-169.
    5. Berardi, Michele, 2021. "Uncertainty, sentiments and time-varying risk premia," MPRA Paper 106922, University Library of Munich, Germany.

    More about this item

    JEL classification:

    • 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
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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