Kaizoji, Taisei (firstname.lastname@example.org) (2010): A behavioral model of bubbles and crashes.
Download (716Kb) | Preview
The aim of this paper is to propose a new model of bubbles and crashes to elucidate a mechanism of bubbles and subsequent crashes. We consider an asset market in which the risky assets into two classes, the risky asset, and the risk-free asset are traded. Investors are divided into two groups of investors who have the different rationality on decision-making respectively. One is arbitragers who maximize their expected utility of their wealth in the next period following their rational assessment of the fundamental values of risky assets. Another is noise traders who maximize their random utility of binary choice: buying the bubble asset and holding the risk-free asst. The noise trader’s behavior is modeled in a framework of the theory of discrete choice with social interaction (Brock and Durlauf (1999, 2001)), which can be considered as a model of Keynse’s beauty contest metaphor. We demonstrate that (i) if noise-traders’ conformity effect (the extent that each noise-trader is influenced by the decisions of other noise-traders) is weak, then the market price converges to the fundamental price, so that the efficient market hypothesis holds, but that (ii) if noise-traders’ conformity effect is strong, then noise-traders’ herd behavior gives cause to a bubble, and their positive-feedback trading prolongs bubble, but a bubble is necessarily ended up with a crash. Furthermore, we describe that cycles of bubbles and crashes are repeated.
|Item Type:||MPRA Paper|
|Original Title:||A behavioral model of bubbles and crashes|
|Keywords:||bubbles, crashes, arbitragers, noise traders, positive-feedback trading, efficient market hypothesis, and Keynesian beauty contest metaphor|
|Subjects:||G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
C - Mathematical and Quantitative Methods > C7 - Game Theory and Bargaining Theory > C73 - Stochastic and Dynamic Games; Evolutionary Games; Repeated Games
G - Financial Economics > G0 - General > G01 - Financial Crises
|Depositing User:||Taisei KAIZOJI|
|Date Deposited:||07. Sep 2012 16:41|
|Last Modified:||15. Feb 2013 19:42|
 Abreu, D., and M. K. Brunnermeier, (2003), Bubbles and Crashes, Econometrica 71, 173-204.
 Allen, F., S. Morris, and H.-S. Shin (2006), Beauty Contests and Iterated Expectations in Asset Markets, Review of Financial Studies 19 no.3, 719-752.
 Angeletos, G.-M., G. Lorenzoni, and A. Pavan (2010), Beauty Contests and Irrational Exuberance: a Neoclassical Approach, NBER Working Paper No. 15883.
 Battalio, R. and P. Shultz (2006), Options and the Bubble, Journal of Finance 59-5 2017-2102.
 Ben-Akiva, M. and S. R. Lerman, (1985) Discrete Choice Analysis: Theory and Application to Travel Demand, The MIT Press.
 Black, F., 1986, Noise, The Journal of Finance, 41 (3), Papers and Proceedings of the Forty-Fourth Annual Meeting of the America Finance Association, New York, New York, December 28-30, 1985. (Jul., 1986), 529-543.
 Biais, B., and P. Bossaerts, (1998), Asset Prices and Trading Volume in a Beauty Contest, Review of Economic Studies 65, 307–340.
 Brennan, M., (2004), How Did It Happen?, Economic Notes 33, 3-22.
 Brock, W.A., Hommes, C.H., 1997. A rational route to randomness. Econometrica 65, 1059-1095.
 Brock, W.A., Hommes, C.H., 1998. Heterogeneous beliefs and routes to chaos in a simple asset pricing model. Journal of Economic Dynamics and Control 22, 1235-1274.
 Brock, William A., and Durlauf, Steven N. (1999), A formal model of theory choice in science, Economic Theory 4, 113-130 (1999).
 Brock, William A., and Durlauf, Steven N. (2001), Discrete choice with social interactions, The Review of Economic Studies, 68, No.2, 235-260.
 Brunnermeier, Markus and Stefan Nagel, (2004), Hedge funds and the technology bubble, Journal of Finance, 59 (5), 2013 - 2040.
 Chen, J., H. Hong, and J. Stein, 2002, Breadth of ownership and stock returns, Journal of Financial Economics 66, 171-205.
 DeBondt, W. F.M., and R. Thaler, (1985), Does the stock market overreact? Journal of Finance 40, 793-808.
 De Long, B. J., A. Shleifer; L. H. Summers; R. J. Waldmann, 1990a, Positive Feedback Investment Strategies and Destabilizing Rational Speculation, The Journal of Finance, 45 (2), 379-395.
 DeLong, J. B., A. Shleifer, L. Summers and R. Waldmann (1990b), Noise trader risk in financial markets, Journal of Political Economy 98, 703-38.
 Friedman, M., 1953, The case for flexible exchange rates, in Milton Friedman, ed.: Essays in Positive Economics (University of Chicago Press, Chicago, IL).  Harrison, J.M. and D.M. Kreps, 1978, Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations, The Quarterly Journal of Economics 92(2), 323-336.
 Gandolfo, G., 1980, Economic Dynamics, Methods and Models, Advanced Textbooks in Economics, Elsevier Science Ltd.
 Greenwood, R., and S. Nagel, (2008), Inexperienced Investors and Bubbles, Journal of Financial Economics, Journal of Financial Economics, Aug 2009, Volume: 93 Issue: 2 pp.239-258.
 Haruvy, Ernan, E., Lahav, Y., and C. Noussair (2007), Traders’ Expectations in Asset Markets: Experimental Evidence, American Economic Review, 97(5): 1901–1920.
 Hong, H. and J. Stein, 1999, A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets, Differences of opinion, shortsales constraints and market crashes, The Journal of Finance, Vol. 54, No. 6. (Dec., 1999), pp. 2143-2184.
 Hong, H. and J. Stein, 2003, Differences of opinion, short-sales constraints and market crashes, Review of Financial Studies 16, 487-525.
 Hong, H., J. Scheinkman, and W. Xiong, 2006, Asset Float and Speculative Bubbles, Journal of Finance 59 (3), 1073-1117.
 Jegadeesh, N., and S. Titman, 1993, “Returns to buying winners and selling losers: Implications for stock market efficiency,” Journal of Finance 48, 65-91.
 Kaizoji, T., Speculative bubbles and crashes in stock markets: an interacting agent model of speculative activity, Physica A. 287, 3-4 (2000), 493-506.
 Keynes, J. M., (1936), The General Theory of Employment, Interest and Money, Macmillan, London.
 Kyle, A. S., 1985, Continuous Auctions and Insider Trading, Econometrica 53, 1315-1335.
 Lintner, J., (1969), The Aggregation of Investor's Diverse Judgments and Preferences in Purely Competitive Security Markets, The Journal of Financial and Quantitative Analysis, Vol. 4, No. 4., pp. 347-400.
 Lee, C., J. Myers and B. Swaminathan (1999), “What is the Intrinsic Value of the Dow?” Journal of Finance. 54, pp.1693–1741.
 Lux, T., (1995), Herd behavior, bubbles and crashes, The Economic Journal, Vol. 105, No. 431 pp. 881-896.
 McFadden, D., (1974) "Conditional Logit Analysis and Qualitative Choice behavior," in Paul Zarembka (ed.), Frontiers in Econometrics (New York: Academic Press).
 Miller, E., 1977, Risk, uncertainty and divergence of opinion, Journal of Finance 32, 1151-1168.  Ofek, E., and M. Richardson, (2003), DotCom Mania: The rise and fall of Internet stock prices, Journal of Finance 58, 1113-1137.
 Smith, V. L., Suchanek, G. L., and Williams, A. W., (1988), Bubbles, Crashes and Endogenous Expectations in Experimental Spot Asset Markets, Econometrica, 56(5), pp. 1119-1151.