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Shocks, Beliefs and Cycles

Paper Session

Saturday, Jan. 5, 2019 2:30 PM - 4:30 PM

Atlanta Marriott Marquis, L406
Hosted By: Econometric Society
  • Chair: Venky Venkateswaran, New York University & Federal Reserve Bank of Minneapolis

Asymmetric Attention

Alexandre Kohlhas
Stockholm University
Ansgar Walther
Imperial College London


We document simultaneous over- and under-responses to new information by households,
firms, and professional forecasters in survey data. Such behavior is inconsistent
with existing theories based on either behavioral bias or rational inattention. We
develop a structural model of information choice in which people base expectations
on observables that can reconcile the seemingly contradictory facts. We show that
optimally-chosen, asymmetric attention to different observables can explain the coexistence of over- and under-responses. We then embed our model of information
choice into a micro-founded macroeconomic model, which generates expectations consistent
with the survey data. We demonstrate that our model creates over-optimistic
consumption beliefs in booms and predictability in consumption changes.

Which Financial Shocks Drive the Business Cycle?

Andrea Ajello
Federal Reserve Board
Jonathan Goldberg
Federal Reserve Board
Ander Perez-Orive
Federal Reserve Board


We develop a monetary dynamic general equilibrium model with a rich corporate finance structure to study which financial shocks drive the business cycle and how. Entrepreneurs optimally choose dividend payouts, long-term nominal debt, and real investment in a setting with idiosyncratic risk and strategic default. We model segmented asset markets and introduce sentiment shocks to the demand for corporate bonds and for long-term bonds whether government or corporate. On the supply side of the corporate credit market, we include an idiosyncratic entrepreneurial risk shock. We estimate the model on US data on corporate financial flows, asset prices, and standard indicators of economic activity. Sentiment shocks generate plausible business cycle responses and can explain around 40 percent of investment and employment fluctuations. Longer debt maturity amplifies the effects of bond market shocks through a debt deflation channel but dampens those effects through a debt rollover channel. Overall, longer debt maturity contributes to lower volatility. Shocks to investor demand for corporate bonds are more important than term premium shocks as drivers of business cycle fluctuations.

Noise-Ridden Lending Cycles

Elena Afanasyeva
Federal Reserve Board
Jochen Guentner
Johannes Kepler University-Linz


This paper studies the effect of noise shocks on the credit supply of financial intermediaries. In our model, a risk-neutral competitive bank solves a signal extraction problem in order to learn about the state of the economy, which determines the default probability of a given loan. A non-fundamental noise shock lowers the equilibrium interest rate on risky credit, increases the share of riskier loans in the bank's portfolio, and leads thus to higher ex-post default. Given that the reduced-form VAR representation is not invertible, we estimate a general equilibrium version of the model in order to recover the structural shocks and find that noise shocks account for up to one third of the forecast error variance in credit spreads and credit volumes.

The Tail that Keeps the Riskless Rate Low

Julian Kozlowski
Federal Reserve Bank of St. Louis
Laura Veldkamp
Columbia University
Venky Venkateswaran
New York University & Federal Reserve Bank of Minneapolis


Riskless interest rates fell in the wake of the financial crisis and have remained low. We
explore a simple explanation: This recession was perceived as an extremely unlikely event
before 2007. Observing such an episode led all agents to re-assess macro risk, in particular,
the probability of tail events. Since changes in beliefs endure long after the event itself has
passed, perceived tail risk remains high, generates a demand for riskless, liquid assets, and
continues to depress the riskless rate. We embed this mechanism in a simple production
economy with liquidity constraints and use observable macro data, along with standard
econometric tools, to discipline beliefs about the distribution of aggregate shocks. When
agents observe an extreme, adverse realization, they re-estimate the distribution and attach
a higher probability to such events recurring. As a result, even transitory shocks have
persistent effects because, once observed, the shock stays forever in the agents’ data set.
We show that our belief revision mechanism can help explain the persistent nature of the
fall in the risk-free rates.
JEL Classifications
  • E3 - Prices, Business Fluctuations, and Cycles
  • G1 - General Financial Markets