Business cycles and stock market volatility : theory and evidence of animal spirits

Abstract

This doctoral dissertation explores the relationship between business cycles, the stock market, and animal spirits. Four chapters are presented. They cover both applicable theory and employ a new econometric tool, Markov Switching Model's (MSM), to estimate equations and test the theories. The animal spirit conjecture is placed in the context of recently developed theories on self-fulfilling 'sunspot' beliefs. The goal is to determine whether rational animal spirits are a plausible explanation of business cycle dynamics and stock market fluctuations. Independence between the business cycle and the stock market is also explored. MSM's are seen to provide a very powerful specification in discerning distinct regimes and asymmetries in the business cycles. The estimated models show multiple equilibria properties that would be present with animal spirits. The evidence is against real business cycle models that assume unique equilibrium and only fundamentals matter. Rationality is an open question, especially with respect to the stock market.