Discussion Paper Details

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Title: Behavioural Theories of the Business Cycle

Author(s): Nir Jaimovich and Sérgio Rebelo

Publication Date: October 2006

Keyword(s): business cycles, expectations, optimism and overconfidence

Programme Area(s): International Macroeconomics

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.

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Bibliographic Reference

Jaimovich, N and Rebelo, S. 2006. 'Behavioural Theories of the Business Cycle'. London, Centre for Economic Policy Research.