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Replicating Business Cycles and Asset Returns with Sentiment and Low Risk Aversion
This paper develops a real business cycle model with eight fundamental shocks andone ìequity sentiment shockî that captures belief-driven áuctuations. I solve for thetime series of shock realizations that allow the model to exactly replicate the observedtime paths of U.S. macroeconomic variables and asset returns over the past six decades.The representative agentís perception that movements in equity value are partly drivenby sentiment is close to self-fulÖlling. The model-identiÖed sentiment shock is stronglycorrelated with other fundamental shocks and implies ìpessimismîrelative to ...