Stock Price Cycles and Business Cycles

82 Pages Posted: 18 Sep 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, 2019


We present a simple model that quantitatively replicates the behavior of stock prices and business cycles in the United States. The business cycle model is standard, except that it features extrapolative belief formation in the stock market, in line with the available survey evidence. Extrapolation amplifies the price effects of technology shocks and - in response to a series of positive technology surprises - gives rise to a large and persistent boom and bust cycle in stock prices. Boom-bust dynamics are more likely when the risk-free interest rate is low because low rates strengthen belief-based amplification. Stock price cycles transmit into the real economy by generating inefficient price signals for the desirability of new investment. The model thus features a 'financial accelerator', despite the absence of financial frictions. The financial accelerator causes the economy to experience persistent periods of over- and under-accumulation of capital.

Keywords: booms and busts, business cycles, financial accelerator, stock market volatility

JEL Classification: E32, E44, G12

Suggested Citation

Adam, Klaus and Merkel, Sebastian, Stock Price Cycles and Business Cycles (September, 2019). Available at SSRN: or

Klaus Adam (Contact Author)

University of Mannheim ( email )

Department of Economics
L7 ,3-5
Mannheim, 68131


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

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

Centre for Economic Policy Research (CEPR) ( email )

United Kingdom

Sebastian Merkel

Princeton University ( email )

22 Chambers Street
Princeton, NJ 08544-0708
United States

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