Sentiment and the Economy: A General Equilibrium Analysis

Project Start:01/2014
Status:Completed
Researchers:Grigory Vilkov
Category: Financial Markets
Funded by:LOEWE

What is the impact of the existence of sentiment traders on real variables, such as output and investment, and on financial variables, such as the level of the stock market and the market price of risk, the level and term structure of the riskless interest rate, and the trading volume in financial markets? And, at a broader level, would more informationally efficient markets function better, be more stable, and increase productivity and welfare? The main contribution of this project is to answer these questions within the same dynamic, stochastic general equilibrium model of a production economy, so that one can compare both the direct and indirect effects of sentiment and information efficiency on the financial and real sectors of an economy within the same economic setting.

The authors show in a robust general equilibrium model how the risks arising from excessive trading in financial markets affect the real side of the economy, as well as consumption sharing, and financial markets. The excessive trading is generated by the existence of sentiment-prone traders who mis-interpret the uninformative signal about the state of the economy and make inefficient consumption and investment decisions. The model is endowed with several production facilities and it is planned to generate a number of empirical predictions to be tested in data.

We have produced the model in an exchange economy that generates necessary dynamics of booms and busts and are currently working out the model that includes the production economy. One paper from the project has the model with production, but modifications are needed based on the feedback from presentations.

 

Related Published Papers

Author/sTitleYearProgram AreaKeywords
Adrian Buss, Bernard Dumas, Raman Uppal, Grigory VilkovThe Intended and Unintended Consequences of Financial-Market Regulations: A General Equilibrium Analysis
Journal of Monetary Economics
2016 Financial Markets Tobin tax, borrowing constraints, short-sale constraints, stock market volatility, incomplete markets, differences of opinion

Related Working Papers

No.Author/sTitleYearProgram AreaKeywords
124Adrian Buss, Bernard Dumas, Raman Uppal, Grigory VilkovThe Intended and Unintended Consequences of Financial-Market Regulations: A General Equilibrium Analysis2016 Financial Markets Tobin tax, borrowing constraints, short-sale constraints, stock market volatility, incomplete markets, differences of opinion
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