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When Are Market Crashes Driven by Speculation?


Leoni, Patrick (2004). When Are Market Crashes Driven by Speculation? Working paper series / Institute for Empirical Research in Economics No. 197, University of Zurich.

Abstract

A natural conjecture is that speculative trade disappears when individual beliefs become correct through learning. Sandroni in [22] gives a counterexample in an economy with sunspots. We generalizenSandroni's result by showing that the conjecture holds for economies with complete markets only. We consider a standard finite-horizon General Equilibrium model with complete markets, where uncertaintynis represented by fluctuations in individual endowments. Individual beliefs are formed through arbitrary learning processes, and become eventually correct. We show that along every path of events, equilibrium prices of traded assets converge to rational expectations for the sup-norm. We also give a set of sufficient conditions on beliefs andnaggregate endowment leading to market crashes, as in Sandroni [22].nWe show that such situations are generically continuous perturbations of rational expectations behaviors when beliefs satisfy a requirementnintroduced here.

Abstract

A natural conjecture is that speculative trade disappears when individual beliefs become correct through learning. Sandroni in [22] gives a counterexample in an economy with sunspots. We generalizenSandroni's result by showing that the conjecture holds for economies with complete markets only. We consider a standard finite-horizon General Equilibrium model with complete markets, where uncertaintynis represented by fluctuations in individual endowments. Individual beliefs are formed through arbitrary learning processes, and become eventually correct. We show that along every path of events, equilibrium prices of traded assets converge to rational expectations for the sup-norm. We also give a set of sufficient conditions on beliefs andnaggregate endowment leading to market crashes, as in Sandroni [22].nWe show that such situations are generically continuous perturbations of rational expectations behaviors when beliefs satisfy a requirementnintroduced here.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Economics
Working Paper Series > Institute for Empirical Research in Economics (former)
Dewey Decimal Classification:330 Economics
Language:English
Date:August 2004
Deposited On:29 Nov 2011 22:32
Last Modified:19 Feb 2018 20:37
Series Name:Working paper series / Institute for Empirical Research in Economics
ISSN:1424-0459
OA Status:Green
Official URL:http://www.econ.uzh.ch/wp.html

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