We present a simple model that quantitatively replicates the behavior of stock pricesandbusiness cycles in the United States. The business cycle model is standard, except that it features extrapolative belief formation in the stock market, in line with the available survey evidence. Extrapolation amplifies the price effects oftechnology shocks and -in response to a series of positive technology surprises - gives rise to a large and persistent boom and bust cycle in stock prices. Boom-bust dynamics are more likely when the risk-free interest rate is low because low rates strengthen belief-based amplification. Stock price cycles transmit into the real economy by generating inefficient price signals for the desirability of new investment.The model thus features a `financial accelerator', despite the absence of financial frictions. The financial accelerator causes the economy to experience persistent periods of over- and under-accumulation of capital.
We present a stock market model that quantitatively replicates the joint behavior of stock prices, trading volume and investor expectations. Stock prices in the model occasionally display belief-driven boom and bust cycles that delink asset prices from fundamentals and redistribute considerable amounts of wealth from less to more experienced investors. Although gains from trade arise only from subjective belief differences, introducing financial transactions taxes (FTTs) remains undesirable. While FTTs reduce the size and length of boom–bust cycles, they increase the likelihood of such cycles, thereby overall return volatility and wealth redistribution. Contingent FTTs, which are levied only above a certain price threshold, give rise to problems of equilibrium multiplicity and non-existence.