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Essays on financial markets and business cycles

Winkler, Fabian (2015) Essays on financial markets and business cycles. PhD thesis, London School of Economics and Political Science.

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This thesis contains three essays on the linkages between financial markets and business cycles. The first chapter introduces a method to embed learning about asset prices (relying on past observation to predict future prices) into business cycle models in a way that retains a maximum of rationality and parsimony. This method is applied to a real business cycle model and a search model of unemployment. In the RBC model, learning about stock prices leads to counterfactual correlations between consumption, employment and investment. By contrast, the search model augmented by learning can generate realistic business cycle fluctuations. The volatility of unemployment in the data can be replicated without the need to rely on a high degree of wage rigidity. The second chapter examines the implications of a learning-based asset pricing theory for a model of firm financial frictions. Learning greatly improves asset price properties such as return volatility and predictability. In combination with financial frictions, a powerful feedback loop emerges between beliefs, stock prices and real activity, leading to substantial amplification of shocks. The model-implied subjective expectations are found to be consistent with patterns of forecast error predictability in survey data. A reaction of monetary policy to asset prices stabilises expectations and substantially improves welfare, which is not the case under rational expectations. The third chapter is concerned with the inefficiencies caused by incomplete national and international financial markets. Specifically, it examines the optimal design of an unemployment insurance scheme that operates across multiple countries in the presence of such inefficiencies. Using a two-country business cycle model with labour market search frictions, it is found that a supranational unemployment insurance scheme can be used to achieve transfers across countries without changing unemployment levels; and that the optimal unemployment insurance policy prescribes a countercyclical replacement rate due in the presence of cross-country transfers.

Item Type: Thesis (PhD)
Additional Information: © 2015 Hans Fabian Winkler
Library of Congress subject classification: H Social Sciences > HB Economic Theory
Sets: Departments > Economics
Supervisor: Den Haan, Wouter J.

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