IDEAS home Printed from https://ideas.repec.org/p/red/sed013/167.html
   My bibliography  Save this paper

A Bayesian DSGE Model of Stock Market Bubbles and Business Cycles

Author

Listed:
  • 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
    as

    Download full text from publisher

    File URL: https://economicdynamics.org/meetpapers/2013/paper_167.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, pages 145-161.
    2. Baker, Malcolm & Stein, Jeremy C., 2004. "Market liquidity as a sentiment indicator," Journal of Financial Markets, Elsevier, pages 271-299.
    3. Iskrev, Nikolay, 2010. "Local identification in DSGE models," Journal of Monetary Economics, Elsevier, pages 189-202.
    4. Miao, Jianjun & Wang, Pengfei, 2015. "Banking bubbles and financial crises," Journal of Economic Theory, Elsevier, pages 763-792.
    5. Alejandro Justiniano & Giorgio Primiceri & Andrea Tambalotti, 2011. "Investment Shocks and the Relative Price of Investment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(1), pages 101-121, January.
    6. Jianjun Miao & Pengfei Wang & Lifang Xu, 2016. "Stock market bubbles and unemployment," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), pages 273-307.
    7. Tomohiro Hirano & Noriyuki Yanagawa, 2010. "Asset Bubbles, Endogenous Growth, and Financial Frictions," CIRJE F-Series CIRJE-F-752, CIRJE, Faculty of Economics, University of Tokyo.
    8. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-248, April.
    9. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 249-265, April.
    10. Susanto Basu & Brent Bundick, 2017. "Uncertainty Shocks in a Model of Effective Demand," Econometrica, Econometric Society, vol. 85, pages 937-958, May.
    11. Robert J. Barro & Robert G. King, 1984. "Time-Separable Preferences and Intertemporal-Substitution Models of Business Cycles," The Quarterly Journal of Economics, Oxford University Press, vol. 99(4), pages 817-839.
    12. Timothy Dunne & Mark J. Roberts & Larry Samuelson, 1988. "Patterns of Firm Entry and Exit in U.S. Manufacturing Industries," RAND Journal of Economics, The RAND Corporation, pages 495-515.
    13. Cogley, Timothy & Nason, James M, 1995. "Output Dynamics in Real-Business-Cycle Models," American Economic Review, American Economic Association, pages 492-511.
    14. Jianjun Miao & Pengfei Wang & Lifang Xu, 2016. "Stock market bubbles and unemployment," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), pages 273-307.
    15. Ippei Fujiwara & Yasuo Hirose & Mototsugu Shintani, 2011. "Can News Be a Major Source of Aggregate Fluctuations? A Bayesian DSGE Approach," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(1), pages 1-29, February.
    16. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco.
    17. Robert S. Chirinko & Huntley Schaller, 2001. "Business Fixed Investment and "Bubbles": The Japanese Case," American Economic Review, American Economic Association, pages 663-680.
    18. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    19. Beaudry, Paul & Portier, Franck, 2004. "An exploration into Pigou's theory of cycles," Journal of Monetary Economics, Elsevier, pages 1183-1216.
    20. Noldeke, Georg & Samuelson, Larry, 1997. "A Dynamic Model of Equilibrium Selection in Signaling Markets," Journal of Economic Theory, Elsevier, pages 118-156.
    21. Pengfei Wang, 2012. "Understanding Expectation‐Driven Fluctuations: A Labor‐Market Approach," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44, pages 487-506, March.
    22. Pengfei Wang & Yi Wen, 2012. "Hayashi Meets Kiyotaki and Moore: A Theory of Capital Adjustment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(2), pages 207-225, April.
    23. Malcolm Baker & Jeremy C. Stein & Jeffrey Wurgler, 2003. "When Does the Market Matter? Stock Prices and the Investment of Equity-Dependent Firms," The Quarterly Journal of Economics, Oxford University Press, vol. 118(3), pages 969-1005.
    24. Nicholas Bloom, 2009. "The Impact of Uncertainty Shocks," Econometrica, Econometric Society, vol. 77(3), pages 623-685, May.
    25. Zheng Liu & Daniel F. Waggoner & Tao Zha, 2011. "Sources of macroeconomic fluctuations: A regime‐switching DSGE approach," Quantitative Economics, Econometric Society, pages 251-301.
    26. Gan, Jie, 2007. "Collateral, debt capacity, and corporate investment: Evidence from a natural experiment," Journal of Financial Economics, Elsevier, vol. 85(3), pages 709-734, September.
    27. Hirano, Tomohiro & Yanagawa, Noriyuki, 2010. "Asset Bubbles, Endogenous Growth, and Financial Frictions," MPRA Paper 24085, University Library of Munich, Germany.
    28. Nikolay Iskrev, 2009. "Local Identification in DSGE Models," Working Papers w200907, Banco de Portugal, Economics and Research Department.
    29. Roland Beck & Sebastian Weber, 2011. "Should Larger Reserve Holdings Be More Diversified?," International Finance, Wiley Blackwell, pages 415-444.
    30. Timothy Dunne & Mark J. Roberts & Larry Samuelson, 1988. "Patterns of Firm Entry and Exit in U.S. Manufacturing Industries," RAND Journal of Economics, The RAND Corporation, pages 495-515.
    31. Gilchrist, Simon & Himmelberg, Charles P. & Huberman, Gur, 2005. "Do stock price bubbles influence corporate investment?," Journal of Monetary Economics, Elsevier, pages 805-827.
    32. Sims, Christopher A & Zha, Tao, 1998. "Bayesian Methods for Dynamic Multivariate Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 949-968, November.
    33. Gertler, Mark & Kiyotaki, Nobuhiro, 2010. "Financial Intermediation and Credit Policy in Business Cycle Analysis," Handbook of Monetary Economics,in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 11, pages 547-599 Elsevier.
    34. Christiano, Lawrence & Rostagno, Massimo & Motto, Roberto, 2010. "Financial factors in economic fluctuations," Working Paper Series 1192, European Central Bank.
    35. Lawrence J. Christiano & Michele Boldrin & Jonas D. M. Fisher, 2001. "Habit Persistence, Asset Returns, and the Business Cycle," American Economic Review, American Economic Association, pages 149-166.
    36. Gilchrist, Simon & Himmelberg, Charles P. & Huberman, Gur, 2005. "Do stock price bubbles influence corporate investment?," Journal of Monetary Economics, Elsevier, pages 805-827.
    37. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, pages 893-910.
    38. Francisco Covas & Wouter J. Den Haan, 2011. "The Cyclical Behavior of Debt and Equity Finance," American Economic Review, American Economic Association, pages 877-899.
    39. Robert S. Chirinko & Huntley Schaller, 2001. "Business Fixed Investment and "Bubbles": The Japanese Case," American Economic Review, American Economic Association, pages 663-680.
    40. Philippe Weil, 1987. "Confidence and the Real Value of Money in an Overlapping Generations Economy," The Quarterly Journal of Economics, Oxford University Press, vol. 102(1), pages 1-22.
    41. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, pages 421-436.
    42. Michele Boldrin & Lawrence J. Christiano & Jonas D. M. Fisher, 2000. "Habit persistence, asset returns and the business cycle," Staff Report 280, Federal Reserve Bank of Minneapolis.
    43. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, pages 421-436.
    44. Lawrence J. Christiano & Michele Boldrin & Jonas D. M. Fisher, 2001. "Habit Persistence, Asset Returns, and the Business Cycle," American Economic Review, American Economic Association, pages 149-166.
    45. Vidhan K. Goyal & Takeshi Yamada, 2004. "Asset Price Shocks, Financial Constraints, and Investment: Evidence from Japan," The Journal of Business, University of Chicago Press, vol. 77(1), pages 175-200, January.
    46. Cogley, Timothy & Nason, James M, 1995. "Output Dynamics in Real-Business-Cycle Models," American Economic Review, American Economic Association, pages 492-511.
    47. Wen, Yi, 1998. "Capacity Utilization under Increasing Returns to Scale," Journal of Economic Theory, Elsevier, vol. 81(1), pages 7-36, July.
    48. Pengfei Wang & Lifang Xu & Jianjun Miao, 2013. "Stock Market Bubbles and Unemployment," 2013 Meeting Papers 720, Society for Economic Dynamics.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Pengfei Wang & Jing Zhou & Jianjun Miao, 2015. "Housing Bubbles and Policy Analysis," 2015 Meeting Papers 1056, Society for Economic Dynamics.
    2. Paul De Grauwe & Eddie Gerba, 2015. "Stock Market Cycles and Supply Side Dynamics: Two Worlds, One Vision?," CESifo Working Paper Series 5573, CESifo Group Munich.
    3. Claire Océane Chevallier & Sarah El Joueidi, 2016. "Regulation and Rational Banking Bubbles in Infinite Horizon," CREA Discussion Paper Series 16-15, Center for Research in Economic Analysis, University of Luxembourg.
    4. Ornella Tarola & Giulia Ceccantoni & Skerdilajda Zanaj, 2016. "Green consumption and relative preferences in an international oligopoly," CREA Discussion Paper Series 16-16, Center for Research in Economic Analysis, University of Luxembourg.

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:red:sed013:167. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann). General contact details of provider: http://edirc.repec.org/data/sedddea.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.