Bubbles and crashes in finance: A phase transition from random to deterministic behaviour in prices.

Fry, J. M. (2010): Bubbles and crashes in finance: A phase transition from random to deterministic behaviour in prices.

Abstract

We develop a rational expectations model of financial bubbles and study ways in which a generic risk-return interplay is incorporated into prices. We retain the interpretation of the leading Johansen-Ledoit-Sornette model, namely, that the price must rise prior to a crash in order to compensate a representative investor for the level of risk. This is accompanied, in our stochastic model, by an illusion of certainty as described by a decreasing volatility function. As the volatility function goes to zero, crashes can be seen to represent a phase transition from stochastic to deterministic behaviour in prices.

• Item Type: MPRA Paper
• Language: English
• Keywords: financial crashes; super-exponential growth; illusion of certainty; housing-bubble
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C53 - Forecasting and Prediction Methods ; Simulation Methods; C - Mathematical and Quantitative Methods > C0 - General > C00 - General; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E37 - Forecasting and Simulation: Models and Applications

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