Errors in survey expectations display waves of pessimism and optimism and significant sluggishness. This paper develops a novel theoretical framework of time-varying beliefs capturing these empirical facts. In our model, the dynamic beliefs arise endogenously due to agents' attitude toward alternative models. Decision-maker's distorted beliefs generate countercyclical risk aversion, procyclical portfolio weights, countercyclical equilibrium asset returns, and excess volatility. A calibrated version of our model is shown to match salient features in equity markets.
This is a joint work with Pascal Maenhout and Andrea Vedolin.

Paper: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3798445 Speaker(s): Hao Xing (Boston University)