- Animal spirits, heterogeneous expectations and the amplification and duration of crises
- CeNDEF Working Paper
- Number of pages
- Universiteit van Amsterdam
- Document type
- Working paper
- Faculty of Economics and Business (FEB)
- Amsterdam School of Economics Research Institute (ASE-RI)
We introduce a simple equilibrium model of a market for loans. Households lend to firms and form expectations about their loan default probability. Under heterogeneous expectations, with switching between forecasting strategies driven by reinforcement learning, even a small fraction of pessimistic traders has a large aggregate effect, causing a heterogeneous expectations risk premium, i.e. significantly higher contract rates for loans and significantly lower output. Our stylized
model illustrates how animal spirits and heterogeneous expectations may lead to aconfidence loss and to financial instability amplifying the magnitude of economic crises and slowing down recovery.
- June, 2012
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