Behavioral Theories of the Business Cycle

12 Pages Posted: 8 Oct 2006 Last revised: 13 Nov 2006

See all articles by Nir Jaimovich

Nir Jaimovich

University of Zurich

Sergio T. Rebelo

Northwestern University - Kellogg School of Management; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: October 2006

Abstract

We explore the business cycle implications of expectation shocks and of two well-known psychological biases, optimism and overconfidence. The expectations of optimistic agents are biased toward good outcomes, while overconfident agents overestimate the precision of the signals that they receive. Both expectation shocks and overconfidence can increase business-cycle volatility, while preserving the model's properties in terms of comovement, and relative volatilities. In contrast, optimism is not a useful source of volatility in our model.

Suggested Citation

Jaimovich, Nir and Tavares Rebelo, Sergio, Behavioral Theories of the Business Cycle (October 2006). NBER Working Paper No. w12570. Available at SSRN: https://ssrn.com/abstract=934765

Nir Jaimovich

University of Zurich ( email )

Sergio Tavares Rebelo (Contact Author)

Northwestern University - Kellogg School of Management ( email )

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Centre for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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