Financial Markets, the Real Economy, and Self-Fulfilling Uncertainties

54 Pages Posted: 7 Mar 2017 Last revised: 16 Jan 2019

See all articles by Jess Benhabib

Jess Benhabib

New York University - Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER)

Xuewen Liu

University of Hong Kong (HKU) - Finance Area, Faculty of Business and Economics

Pengfei Wang

HKUST, Department of Economics; Hong Kong University of Science & Technology (HKUST) - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: September 2018

Abstract

We develop a general equilibrium model of informational interdependence between financial markets and the real economy, linking economic uncertainty to information production and aggregate economic activities. The mutual learning between financial markets and the real economy creates a strategic complementarity in their information production, leading to self-fulfilling surges in economic uncertainties. In a dynamic setting, our model characterizes self-fulfilling uncertainty traps with two steady-state equilibria and a two-stage economic crisis in transitional dynamics.

Keywords: Information production, Strategic complementarity, Real economy, Two-way learning, Economic uncertainty

JEL Classification: G01, G20, E2, E44

Suggested Citation

Benhabib, Jess and Liu, Xuewen and Wang, Pengfei, Financial Markets, the Real Economy, and Self-Fulfilling Uncertainties (September 2018). Journal of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2927304 or http://dx.doi.org/10.2139/ssrn.2927304

Jess Benhabib

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

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Xuewen Liu (Contact Author)

University of Hong Kong (HKU) - Finance Area, Faculty of Business and Economics ( email )

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Pengfei Wang

HKUST, Department of Economics ( email )

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Hong Kong

Hong Kong University of Science & Technology (HKUST) - Department of Economics ( email )

Clear Water Bay
Kowloon, Hong Kong
China

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