SPOTTING SUNSPOTS - SOME EVIDENCE IN SUPPORT OF MODELS WITH SELF-FULFILLING PROPHECIES

This paper adds financial assests to Roger Farmer's business cycle mod el with increasing returns and self-fulfilling beliefs. By using infor mation from the financial markets in conjunction with the structure of the model, we can uncover from financial data the belief shocks that drive the model. Specifically, we assume that belief shocks drive both economic fluctuations and asset returns. The financial market informa tion allows us to identify these shocks. We use our methods to generat e dynamic simulations of the model and show that it has incremental pr edictive power for key US time series. (C) 1998 Elsevier Science B.V. All rights reserved.