News-driven Business Cycles: Evidence from Investors’ Expectations of Future Stock Market Returns

Abstract

This paper uses a time series of investors’ expectations of future stock market returns, which is proposed by Greenwood and Shleifer (2014), as a new proxy for expectations of future economic developments. Incorporating this measure of expectations into otherwise standard VAR models and implementing the approach of sign restrictions to identify news shocks, we provide empirical evidence in favor of the news-driven business cycles hypothesis. New shocks identified by exploiting movements in the measure of investors’ expectations are found to induce a generalized boom of the economy that is associated with delayed and permanent increases in total factor productivity, but not with its current improvements.