Stock Price Cycles and Business Cycles

68 Pages Posted: 16 Feb 2019

See all articles by Klaus Adam

Klaus Adam

University of Mannheim; European Central Bank (ECB) - Department of Research; Centre for Economic Policy Research (CEPR)

Sebastian Merkel

Princeton University

Multiple version iconThere are 3 versions of this paper

Date Written: September 1, 2018

Abstract

We present a unified and quantitatively credible explanation for the joint behavior of stock prices and business cycles. We consider a frictionless production economy with time-separable consumption preferences and perfectly √°exible labor supply. Investors extrapolate past stock price gains but are rational otherwise. The model replicates a standard set of asset pricing and business cycle moments, as well as moments capturing the interaction between business cycles and stock prices. The model generates belief-driven stock price booms that are associated with a corresponding boom in hours worked and investment. Once the boom turns into a bust, output, hours and investment remain persistently depressed. The model predicts that 75% of the observed √°uctuations in the price-dividend ratio and 13% of observed output √°uctuations are attributable to subjective price extrapolation by investors.

JEL Classification: E32, G12

Suggested Citation

Adam, Klaus and Merkel, Sebastian, Stock Price Cycles and Business Cycles (September 1, 2018). Available at SSRN: https://ssrn.com/abstract=3329820 or http://dx.doi.org/10.2139/ssrn.3329820

Klaus Adam (Contact Author)

University of Mannheim ( email )

Department of Economics
L7 ,3-5
Mannheim, 68131
Germany

HOME PAGE: http://adam.vwl.uni-mannheim.de/1528.0.html

European Central Bank (ECB) - Department of Research ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 6597 (Phone)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Sebastian Merkel

Princeton University ( email )

22 Chambers Street
Princeton, NJ 08544-0708
United States

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