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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.

Suggested Citation

  • Zhiwei Xu & Pengfei Wang & Jianjun Miao, 2013. "A Bayesian DSGE Model of Stock Market Bubbles and Business Cycles," 2013 Meeting Papers 167, Society for Economic Dynamics.
    • Handle: RePEc:red:sed013:167
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    1. Pengfei Wang & Jing Zhou & Jianjun Miao, 2015. "Housing Bubbles and Policy Analysis," 2015 Meeting Papers 1056, Society for Economic Dynamics.
    2. De Grauwe, Paul & Gerba, Eddie, 2018. "The role of cognitive limitations and heterogeneous expectations for aggregate production and credit cycle," Journal of Economic Dynamics and Control, Elsevier, vol. 91(C), pages 206-236.
    3. Miao, Jianjun, 2014. "Introduction to economic theory of bubbles," Journal of Mathematical Economics, Elsevier, vol. 53(C), pages 130-136.
    4. Wesselbaum, Dennis, 2019. "Jobless recoveries: The interaction between financial and search frictions," Journal of Macroeconomics, Elsevier, vol. 61(C), pages 1-1.
    5. Miao, Jianjun & Wang, Pengfei, 2015. "Banking bubbles and financial crises," Journal of Economic Theory, Elsevier, vol. 157(C), pages 763-792.
    6. 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.
    7. Paul De Grauwe & Eddie Gerba, 2015. "Stock Market Cycles and Supply Side Dynamics: Two Worlds, One Vision?," CESifo Working Paper Series 5573, CESifo.
    8. de Grauwe, Paul & Gerba, Eddie, 2015. "Stock market cycles and supply side dynamics," FinMaP-Working Papers 45, Collaborative EU Project FinMaP - Financial Distortions and Macroeconomic Performance: Expectations, Constraints and Interaction of Agents.
    9. Claire Océane Chevallier & Sarah El Joueidi, 2016. "Regulation and Rational Banking Bubbles in Infinite Horizon," DEM Discussion Paper Series 16-15, Department of Economics at the University of Luxembourg.
    10. Ceccantoni, Giulia & Tarola, Ornella & Zanaj, Skerdilajda, 2018. "Green Consumption and Relative Preferences in a Vertically Differentiated International Oligopoly," Ecological Economics, Elsevier, vol. 149(C), pages 129-139.

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