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Quantitative Finance > General Finance

Title: An Endogenous Mechanism of Business Cycles

Abstract: This paper suggests that business cycles may be a manifestation of coupled economy-market dynamics and describes a mechanism that can generate economic fluctuations consistent with observed business cycles. To this end, we seek to incorporate into the macroeconomic framework a dynamic stock market model based on opinion interactions (Gusev et al., 2015). We derive this model from microfoundations, provide its empirical verification including market return prediction (backtested and live-track), demonstrate that it contains the efficient market as a particular regime and establish a link through which economic models can be attached for the study of economy-market interaction. To examine key effects, we link this market model with a simple economic model (Blanchard, 1981). The coupled system generates nontrivial endogenous dynamics, which exhibit deterministic and stochastic features, producing quasiperiodic fluctuations (business cycles). We also inspect this system's behavior in the phase space. The economy and the market are shown to coevolve dynamically along the path governed by a stochastically-forced dynamical system with two stable equilibria, one where the economy expands and the other where it contracts, resulting in business cycles identified as the coherence resonance phenomenon. Thus, the incorporation of market dynamics into the macroeconomic framework, as presented here, allows the derivation of realistic behaviors in a tractable setting, and so could enhance models applied for policy analysis.
Comments: 54 pages
Subjects: General Finance (q-fin.GN); Physics and Society (physics.soc-ph)
Cite as: arXiv:1803.05002 [q-fin.GN]
  (or arXiv:1803.05002v2 [q-fin.GN] for this version)

Submission history

From: Tatiana Losseva [view email]
[v1] Tue, 6 Mar 2018 09:24:41 GMT (2167kb)
[v2] Fri, 16 Mar 2018 11:02:33 GMT (2318kb)