Animal Spirits, Heterogeneous Expectations and the Amplification and Duration of Crises

39 Pages Posted: 4 Jul 2012 Last revised: 5 Jul 2012

Tiziana Assenza

Catholic University of Milan; University of Amsterdam - CeNDEF

C. H. Hommes

University of Amsterdam; CeNDEF; Tinbergen Institute

William A. Brock

University of Wisconsin, Madison - Department of Economics; University of Missouri at Columbia - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: June 30, 2012

Abstract

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

Assenza, Tiziana and Hommes, C. 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

Tiziana Assenza (Contact Author)

Catholic University of Milan ( email )

University of Amsterdam - CeNDEF ( email )

Roetersstraat 11
Amsterdam, NL-1018WB
Netherlands

C. H. Hommes

University of Amsterdam ( email )

Roetersstraat 11
Amsterdam, 1018WB
Netherlands

CeNDEF ( email )

Roetersstraat 11
Amsterdam, NL-1018WB
Netherlands

HOME PAGE: http://www1.fee.uva.nl/cendef/

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

William A. Brock

University of Wisconsin, Madison - Department of Economics ( email )

1180 Observatory Drive
Madison, WI 53706
United States
608-263-6655 (Phone)
608-263-3876 (Fax)

University of Missouri at Columbia - Department of Economics ( email )

118 Professional Building
Columbia, MO 65211
United States

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