Working Paper: NBER ID: w31578
Authors: Pedro Bordalo; Nicola Gennaioli; Rafael La Porta; Matthew O'Brien; Andrei Shleifer
Abstract: In line with Keynes’ intuition, volatility in the stock market and in real economic activity are linked by expectations of long term profits. We show that analysts’ optimism about the long term earnings growth of S&P 500 firms is associated with a near term boom in major US financial markets, real investment, and other business cycle indicators. The same optimism however predicts disappointing earnings growth and a contraction in financial markets and real activity one to two years later. Overreaction of measured long term profit expectations emerges as a promising mechanism for reconciling Shiller’s excess volatility puzzle with the business cycle.
Keywords: Long-term expectations; Aggregate fluctuations; Business cycles; Investment volatility; Nonrational expectations
JEL Codes: E0; E32; E44; E7; G01; G10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| long-term profit expectations (LTG) (D25) | future disappointments in earnings growth (D25) |
| long-term profit expectations (LTG) (D25) | investment boom (E22) |
| long-term profit expectations (LTG) (D25) | growth in consumption (F62) |
| long-term profit expectations (LTG) (D25) | growth in employment (O49) |
| long-term profit expectations (LTG) (D25) | near-term increases in interest rates (E43) |
| long-term profit expectations (LTG) (D25) | long-term decline in interest rates (E43) |
| long-term profit expectations (LTG) (D25) | stock market fluctuations (G10) |