This Time is Different

Systematic deviations from ostensibly rational beliefs appear in many economic, financial, and business contexts. This paper intro- duces a steady-state competitive equilibrium model (Hopenhayn (1992), Melitz (2003)) where firms maximize expected profit and hold beliefs that are calibrated with market aggregates. Each firm believes that aggregates statistics accurately describe the distribution of productivities of others but, when it comes to its own project, it believes it is special, that ‘this time is different.’ In the steady-state equilibrium, all firms and outside observers agree that, in the aggregate, market participants are optimistic and that there is over-entry. Markets respond to this collective ‘bias’ through a combination of lower prices, higher failure rates, and tighter credit. The model is consistent with empirical studies suggesting that corporate financing arrangements display credit-rationing, cash flow sensitivity, and pricing capital at a cost that firms view as too high.