Orlando Gomes, Lisbon Accounting and Business School (ISCAL/IPL), Portugal

Abstract: In order to incorporate animal spirits in a scientifically rigorous inquiry about the causes of aggregate business cycles, one needs to explore the foundations of human behavior, namely concerning the process through which sentiment switching occurs. Which factors drive human sentiments? In what conditions a pessimistic individual becomes an optimist, or the other way around? Is it possible to justify persistent waves of optimism and pessimism under reasonable assumptions concerning social behavior? This article proposes a framework to address the posed questions. The setup is based on rumor propagation theory and it explains how social interaction may lead individuals to change from one sentiment state to the other, eventually triggering a rotation between periods of dominant optimism and periods of dominant pessimism.

Keywords: animal spirits, waves of optimism and pessimism, sentiment propagation, steady-state analysis, transitional dynamics, endogenous fluctuations, interactive Markov chain