Bubbles and crashes: Gradient dynamics in financial markets (original) (raw)
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Computational Economics, 1998
We present a dynamical theory of asset price bubbles that exhibits the appearance of bubbles and their subsequent crashes. We show that when speculative trends dominate over fundamental beliefs, bubbles form, leading to the growth of asset prices away from their fundamental value. This growth makes the system increasingly susceptible to any exogenous shock, thus eventually precipitating a crash. We also present computer experiments which in their aggregate behavior confirm the predictions of the theory.
Bubblesandcrashes:Gradientdynamicsinï¬nancial markets
2008
Fund managers respond to the payoff gradient by continuously adjusting leverage in our analytic and simulation models. The base model has a stable equilibrium with classic properties. However, bubbles and crashes occur in extended models incorporating an endogenous market risk premium based on investors' historical losses and constant-gain learning. When losses have been small for a long time, asset prices inflate as fund managers increase leverage. Then slight losses can trigger a crash, as a widening risk premium accelerates deleveraging and asset price declines.
Economics Letters, 2013
• An asset pricing model where agents forecast the conditional variance of a stock's return. • Agents believe prices follow a random walk with a conditional variance that is self-fulfilling.
Bubbles and Crashes: Escape Dynamics in Financial Markets
2000
We develop a financial market model focused on fund managers who continuously adjust their exposure to risk in response to the payo gradient. The base model has a stable equilibrium with classic properties. However, bubbles and crashes occur in extended models incorporating an endogenous market risk premium based on investors' historical losses and constant gain learning. When losses have been
Efficient Markets and Financial Bubbles
2017
When it comes to money and investing, the individual portfolio investor is not always as rational as he believes he is – which is why there's a whole field of study that explains an individual‟s sometimes irrational and strange behavior. This research paper mainly deals with the insight into the theory and findings of behavioral finance and the financial bubbles in history. The paper will also assist individual investors to avoid these “mental mistakes and errors” by recommending some important investment strategies for those who invest in stocks and mutual funds.
N ° 2008-62 Bubbles and crashes with partially sophisticated investors
2011
We consider a purely speculative market with nite horizon and complete information. We introduce partially sophisticated investors, who know the average buy and sell strategies of other traders, but lack a precise understanding of how these strategies depend on the history of trade. In this setting, it is common knowledge that the market is overvalued and bound to crash, but agents hold di¤erent expectations about the date of the crash. We de ne conditions for the existence of equilibrium bubbles and crashes, characterize their structure, and show how bubbles may last longer when the amount of fully rational traders increases. Keywords: Speculative bubbles, crashes, bounded rationality. JEL codes: D84, G12, C72. We thank numerous seminar participants and in particular Cedric Argenton, Abhijit Banerjee, Markus Brunnermeier, Mike Burkart, Sylvain Chassang, Gabrielle Demange, Daniel Dorn, Tore Ellingsen, Botond Koszegi, John Moore, Marco Ottaviani, Peter Raupach, Marcus Salomonsson, J...
Learning about Risk and Return: A Simple Model of Bubbles and Crashes
American Economic Journal: Macroeconomics, 2011
This paper demonstrates that an asset pricing model with least-squares learning can lead to bubbles and crashes as endogenous responses to the fundamentals driving asset prices. When agents are risk-averse they generate forecasts of the conditional variance of a stock's return. Recursive updating of the conditional variance and expected return implies two mechanisms through which learning impacts stock prices: occasional shocks may lead agents to lower their risk estimate and increase their expected return, thereby triggering a bubble; along a bubble path recursive estimates of risk will increase and crash the bubble. JEL Classifications: G12; G14; D82; D83
Bubbles, Behavioral Finance, and Investor Mentality
2017
"Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation." —JOHN MAYNARD KEYNES Is investor behavior rational during times of high market volatility, bear, and bull markets? If investors are armed with the knowledge that markets can be vulnerable to irrational exuberance1 And, therefore, causing speculative bubbles, how can they improve their decision-making process during these periods of market change? These questions can begin to be answered by understanding the history and theory of behavioral finance and learning to implement the lessons that it teaches. Given the current academic understanding of behavioral finance theory: how people think and react to market bubbles; the majority of investors, advisors, and institutions do not act rationally during times of changing market conditions. Investors can correct their decision making processes during times of financial bubbles by learning from past market bubbles, understanding behavioral finance theory, learning to implement its concepts through self reflection of one’s rational expectations, recognizing and understanding their mistakes and those of others, and garnering self control of one’s actions and decisions during any type of financial situation.
DEMYSTIFYING BUBBLES IN ASSET PRICES
Pennsylvania Economic Review, 2018
This paper provides a survey of asset price bubbles. I focus on the theoretical model for pricing assets from both a classical rational expectations model as well as some of the theories from newer behavioral models. A review of empirical methods used to estimate bubbles is presented along with an examination of the difficulties of empirically identifying bubbles in asset prices. I provide a discussion of the role of central banks and whether a response to asset-price bubbles is appropriate on their part and conclude with a summary of some of the more famous bubbles throughout history.