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The Increased Importance of Asset Price Misalignments for Business Cycle Dynamics
Uppsala University, Disciplinary Domain of Humanities and Social Sciences, Faculty of Social Sciences, Department of Economics.
University of Exeter Business School.
2011 (English)Report (Other academic)
Abstract [en]

We outline a dynamic stochastic general equilibrium (DSGE) model with trend extrapolation in asset pricing that we fit to quarterly U.S. macroeconomic time series with Baye-sian techniques. To be more precise, we modify the DSGE model in Smets and Wouters (2007) by incorporating asset traders who use a mix of fundamental analysis and trend extrapolation in asset pricing. We conclude that trend extrapolation in asset pricing is quantitatively relevant, statistically significant and results in a substantial improvement of the model’s fit to the data. We also find that the strength in trend extrapolation is much stronger during the Great Moderation than it was prior to this period. Moreover, allowing for asset mispricing leads to more pronounced hump-shaped dynamics of the asset price and investment. Thus, asset price misalignments should be an important ingredient in DSGE models that aim to understand business cycles dynamics in general and the interaction between the real and financial sectors in particular.

Place, publisher, year, edition, pages
Uppsala: Department of Economics, Uppsala University , 2011. , 32 p.
Series
Working paper / Department of Economics, Uppsala University (Online), ISSN 1653-6975 ; 2011:12
Keyword [en]
Asset Price Bubble; Bayesian Technique; Business Cycle; DSGE Model; Fun-damental Analysis; Trend Extrapolation
National Category
Economics
Research subject
Economics
Identifiers
URN: urn:nbn:se:uu:diva-154936OAI: oai:DiVA.org:uu-154936DiVA: diva2:422649
Available from: 2011-06-14 Created: 2011-06-13 Last updated: 2011-11-09Bibliographically approved

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