Abstract
AbstractThis paper proposes an empirical test for Minskyan financial cycles in asset prices, driven by the interaction of fundamentalist and momentum traders. Both agents’ beliefs about the future are unobserved and can be modelled in a state space model. We use the Kalman filter to identify the two behavioral rules and evaluate whether the conditions for the existence of cycles hold. The model is estimated for equity and housing prices for France, Germany, the UK and the United States, for the period 1970–2017, with annual and quarterly data. We find robust empirical support for the existence of endogenous financial cycles in equity markets for all countries and for France, the UK and the United States for housing markets.
Highlights
During the Great Moderation period, standard macroeconomic models paid limited attention to financial cycles. Borio (2014) criticizes the fact that the New Keynesian dynamic stochastic general equilibrium paradigm has regarded finance as a veil that it has been ignored in the studies of business fluctuations and that financial crises were interpreted as the result of exogenous shocks
Minsky emphasizes the role of financial factors in a capitalist economy, characterized by the gradual emergence of endogenous financial fragility which eventually turns the boom into a bust (Ferri and Minsky, 1992; Vercelli, 2000)
The contribution of this paper is to provide an empirical test for endogenous financial cycles that emerge from the interaction of the two latent pricing strategies
Summary
During the Great Moderation period, standard macroeconomic models paid limited attention to financial cycles. Borio (2014) criticizes the fact that the New Keynesian dynamic stochastic general equilibrium paradigm has regarded finance as a veil that it has been ignored in the studies of business fluctuations and that financial crises were interpreted as the result of exogenous shocks. A second family describes cycles as the outcome of the interaction to two asset pricing strategies on financial markets. This latter family overlaps with behavioral economics models (Franke and Westerhoff, 2017). We estimate the parameters associated with the two price strategies to analyze the presence of financial cycles and the relative shares of the two economic agents in the market. This method serves as a valuable instrument to search for empirical evidence of endogenous financial cycles in a context of an unobserved components model.
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