Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/264484 
Year of Publication: 
2022
Series/Report no.: 
ECB Working Paper No. 2659
Publisher: 
European Central Bank (ECB), Frankfurt a. M.
Abstract: 
Swift changes in investors' sentiment, such as the one triggered by COVID-19 global outbreak in March 2020, lead to financial tensions and asset price volatility. We study the interactions of behavioral and financial frictions in an environment with endoge- nous risk-taking and capital accumulation. Agents form diagnostic expectations about future stochastic outcomes: recent realizations of aggregate shocks are expected to persist. This behavioral friction gives rise to sentiment cycles with excessive invest- ment and occasional safety traps. The interactions with financial frictions lead to an endogenous amplification of financial instability. We discuss implications for policy interventions.
Subjects: 
Financial Cycles
Diagnostic Beliefs
Macro-prudential Policy
JEL: 
E32
E44
E71
Persistent Identifier of the first edition: 
ISBN: 
978-92-899-5108-1
Document Type: 
Working Paper

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