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Behavioral Theories of the Business Cycle


  • Nir Jaimovich

    () (Department of Economics, Stanford University)

  • Sergio Rebelo

    (Northwestern University)


We explore the business cycle implications of expectation shocks and of two well-known psychological biases, optimism and overconfidence. The expectations of optimistic agents are biased toward good outcomes, while overconfident agents overestimate the precision of the signals that they receive. Both expectation shocks and overconfidence can increase business-cycle volatility, while preserving the model's properties in terms of comovement, and relative volatilities. In contrast, optimism is not a useful source of volatility in our model.

Suggested Citation

  • Nir Jaimovich & Sergio Rebelo, 2006. "Behavioral Theories of the Business Cycle," Discussion Papers 07-015, Stanford Institute for Economic Policy Research.
  • Handle: RePEc:sip:dpaper:07-015

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    References listed on IDEAS

    1. Danthine, Jean-Pierre & Donaldson, John B. & Johnsen, Thore, 1998. "Productivity growth, consumer confidence and the business cycle," European Economic Review, Elsevier, vol. 42(6), pages 1113-1140, June.
    2. Markus K. Brunnermeier & Jonathan A. Parker, 2005. "Optimal Expectations," American Economic Review, American Economic Association, vol. 95(4), pages 1092-1118, September.
    3. Söderlind, Paul, 2005. "C-CAPM without Ex Post Data," SIFR Research Report Series 39, Institute for Financial Research.
    4. Greenwood, Jeremy & Hercowitz, Zvi & Krusell, Per, 2000. "The role of investment-specific technological change in the business cycle," European Economic Review, Elsevier, vol. 44(1), pages 91-115, January.
    5. 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.
    6. Nir Jaimovich & Sergio Rebelo, 2009. "Can News about the Future Drive the Business Cycle?," American Economic Review, American Economic Association, vol. 99(4), pages 1097-1118, September.
    7. Beaudry, Paul & Portier, Franck, 2004. "An exploration into Pigou's theory of cycles," Journal of Monetary Economics, Elsevier, vol. 51(6), pages 1183-1216, September.
    8. Christiano, Lawrence & Motto, Roberto & Rostagno, Massimo & Ilut, Cosmin, 2008. "Monetary policy and stock market boom-bust cycles," Working Paper Series 955, European Central Bank.
    9. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-396, March.
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    Cited by:

    1. Steinar Holden, 2012. "Implications of insights from behavioral economics for macroeconomic models," IMK Working Paper 99-2012, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
    2. Carlos Garcia & Andrés Sagner, 2012. "Exceso de Toma de Riesgo Crediticio en Chile," ILADES-Georgetown University Working Papers inv280, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines.
    3. Bachmann, Rüdiger & Elstner, Steffen, 2015. "Firm optimism and pessimism," European Economic Review, Elsevier, vol. 79(C), pages 297-325.
    4. repec:eee:eecrev:v:100:y:2017:i:c:p:293-317 is not listed on IDEAS
    5. Nielsen, Carsten Krabbe, 2015. "The loan contract with costly state verification and subjective beliefs," Mathematical Social Sciences, Elsevier, vol. 78(C), pages 89-105.
    6. Argentiero, Amedeo & Bovi, Maurizio & Cerqueti, Roy, 2015. "Over consumption. A horse race of Bayesian DSGE models," MPRA Paper 66445, University Library of Munich, Germany.
    7. Driscoll, John C. & Holden, Steinar, 2014. "Behavioral economics and macroeconomic models," Journal of Macroeconomics, Elsevier, vol. 41(C), pages 133-147.
    8. Suda, J., 2013. "Belief shocks and the macroeconomy," Working papers 434, Banque de France.
    9. Carlos Garcia & Andrés Sagner, 2011. "Crédito, Exceso de Toma de Riesgo, Costo del Crédito y Ciclo Económico en Chile," ILADES-Georgetown University Working Papers inv271, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines.
    10. Ioan Roxana, 2015. "The Influence Of Stock Market Investors’ Behavior On Business Cycles," Annals - Economy Series, Constantin Brancusi University, Faculty of Economics, vol. 6, pages 136-144, December.
    11. Lennart Erixon & Louise Johannesson, 2015. "Is the psychology of high profits detrimental to industrial renewal? Experimental evidence for the theory of transformation pressure," Journal of Evolutionary Economics, Springer, vol. 25(2), pages 475-511, April.
    12. Kevin J. Lansing, 2008. "Speculative growth and overreaction to technology shocks," Working Paper Series 2008-08, Federal Reserve Bank of San Francisco.
    13. Doshchyn, Artur & Giommetti, Nicola, 2013. "Learning, Expectations, and Endogenous Business Cycles," MPRA Paper 49617, University Library of Munich, Germany.
    14. Dmitriev, Mikhail, 2009. "Confidence of Agents and Market Frictions," MPRA Paper 21149, University Library of Munich, Germany.

    More about this item


    business cycle; optimism; overconfidence; volatility;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles


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