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Stock market cycles and supply side dynamics

de Grauwe, Paul and Gerba, Eddie (2015) Stock market cycles and supply side dynamics. FinMaP working paper (45). FinMaP, Kiel, Germany.

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Abstract

The agent-based (behavioural) model is extended to include a financial friction on the supply side. Firms finance capital purchases using external financing, but need to pay for it in advance. In addition, firm financing constraint and net worth are determined by stock market prices, which can (and will) deviate from the fundamental value. The result is that production, supply of credit and the share that firms pay to capital producers heavily depends on the stock market cycles. During phases of optimism, credit is abundant, access to production capital is easy, the cash-in-advance constraint is lax, the risks are undervalued, and production is booming. But upon reversal in market sentiment, the contraction in all these parameters is deeper and asymmetric. This is even more evident in the behavioural model since cognitive limitations of economic agents result in exacerbation of the contraction. Lastly, the behavioural model matches much of the data, including the interest rate, inflation, firm credit, firm financing spread, and bank net worth. It is also successful in matching several supply-side relations (capital-firm credit, inflation-interest rate) as well as their autocorrelations. The results from the empirical validation are favourable to the behavioural model.

Item Type: Monograph (Working Paper)
Official URL: http://www.finmap-fp7.eu/index.html
Additional Information: © 2015 The Authors
Divisions: European Institute
Subjects: H Social Sciences > HG Finance
JEL classification: B - Schools of Economic Thought and Methodology > B4 - Economic Methodology > B41 - Economic Methodology
C - Mathematical and Quantitative Methods > C6 - Mathematical Methods and Programming > C63 - Computational Techniques
C - Mathematical and Quantitative Methods > C6 - Mathematical Methods and Programming > C68 - Computable General Equilibrium Models
E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E22 - Capital; Investment (including Inventories); Capacity
E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E23 - Production
E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E37 - Forecasting and Simulation
Sets: Departments > European Institute
Collections > Economists Online
Date Deposited: 27 Jul 2015 11:38
Last Modified: 15 Jul 2019 23:26
Projects: 612955
Funders: European Union’s Seventh Framework Programme
URI: http://eprints.lse.ac.uk/id/eprint/62813

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