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

Abstract

We introduce a simple equilibrium model of a market for loans, where households lend to firms based on heterogeneous expectations about their loan default probability. Agents select endogenously among heterogeneous expectation rules, based upon their relative performance. Due to strong nonlinearities, a small fraction of pessimistic traders already has a large aggregate effect, leading to a crisis characterized by high interest rates for loans and low output. Our stylized model illustrates how animal spirits and heterogeneous expectations and, in particular, how coordination on pessimistic expectations amplifies crises and slows down recovery. (JEL E32, D83, D84)

Peculiarity of Behavior of Economic Agents under Cognitive Constraints in a Semi-Open New Keynesian Model

“…It should be noted that empirical evidence of the heterogeneity of agents and their limited cognitive abilities has been provided using both laboratory data and survey data [12][13][14][15][16]. Researchers have only recently begun to incorporate elements of behavioral economics into dynamic macromodels [17][18][19][20]. In addition, some publications highlight that the linearity implied by standard rational expectations DSGE models makes them not fully suitable for monetary and fiscal policy analysis.…”

A behavioral model of the credit cycle

“…Likewise, the action of a rather small fraction of optimistic agents may give rise to or amplify an expansionary phase. More recently, De Grauwe and Macchiarelli (2015) show how a banking sector may amplify the scope of these movements, exacerbating boom and bursts and explores the stabilizing role of monetary policy and of banking regulation, and in a similar way Assenza et al (2017) develop an heterogenous expectations switching model showing how pessimistic expectations can widen crisis and at the same time play down recoveries.…”

Patience is a Virtue - In Value Investing

“…Heterogeneous agent models of financial markets (HAMs) however build on the premise that all investors are equally patient (or impatient). Their willingness to move their capital between investment styles depends only on differences in realized performance; see the seminal work on theoretical modeling by Hommes (2013); Hommes and Wagener (2009), and recent applied studies, e.g., Grazzini et al (2017); Kukacka and Barunik (2017), Coqueret (2017), and Assenza et al (2017).…”