Real business cycles, animal spirits, and stock market valuation

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.

Replicating Business Cycles and Asset Returns with Sentiment and Low Risk Aversion

“…The remaining six shocks, including the labor disutility shock, can be classi…ed as supply shocks. The model builds on the setup in Lansing (2019) to include three additional fundamental shocks. These include a time-varying risk aversion coe¢ cient, a shock that in ‡uences the productivity of "investor e¤ort" in the production of new capital, and a shock that in ‡uences the real value of bond coupon payments.…”

Replicating Business Cycles and Asset Returns with Sentiment and Low Risk Aversion

“…Lansing and LeRoy (2014) provide a recent update on this literature.18 There are a variety of ways in which sentiment or animal spirits-type mechanisms can be incorporated into quantitative business cycle models. For a brief review, seeLansing (2019).…”

Replicating and projecting the path of COVID-19 with a model-implied reproduction number

“… 5 The model-implied can be viewed as a reverse-engineered stochastic shock. For examples of this approach in economics, see Gelain, Lansing, & Natvik, 2018 and Lansing (2019) . …”