39 Pages Posted: 4 Jul 2012 Last revised: 5 Jul 2012
Date Written: June 30, 2012
We introduce a simple equilibrium model of a market for loans. Households lend to firms and form expectations about their loan default probability. Under heterogeneous expectations, with switching between forecasting strategies driven by reinforcement learning, even a small fraction of pessimistic traders has a large aggregate effect, causing a heterogeneous expectations risk premium, i.e. significantly higher contract rates for loans and significantly lower output. Our stylized model illustrates how animal spirits and heterogeneous expectations may lead to a confidence loss and to financial instability amplifying the magnitude of economic crises and slowing down recovery.
Keywords: Heterogeneous Expectations, Crises, Animal Spirits
JEL Classification: E32, D83, D84
Suggested Citation: Suggested Citation
Assenza, Tiziana and Hommes, Cars H. and Brock, William A., Animal Spirits, Heterogeneous Expectations and the Amplification and Duration of Crises (June 30, 2012). Available at SSRN: https://ssrn.com/abstract=2099350 or http://dx.doi.org/10.2139/ssrn.2099350