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Pricking asset market bubbles

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  • Schmitt, Noemi
  • Westerhoff, Frank

Abstract

We propose an asset-pricing model in which investors switch between extrapolative and regressive expectation rules subject to an evolutionary fitness measure and show that central banks may tame endogenous expectations-driven boom-bust cycles by adjusting interest rates with a view to the market’s momentum.

Suggested Citation

  • Schmitt, Noemi & Westerhoff, Frank, 2021. "Pricking asset market bubbles," Finance Research Letters, Elsevier, vol. 38(C).
    • Handle: RePEc:eee:finlet:v:38:y:2021:i:c:s154461231930844x
    DOI: 10.1016/j.frl.2020.101441
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    References listed on IDEAS

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    1. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
    2. Roberto Dieci & Xue-Zhong He, 2018. "Heterogeneous Agent Models in Finance," Research Paper Series 389, Quantitative Finance Research Centre, University of Technology, Sydney.
    3. Nouriel Roubini, 2006. "Why Central Banks Should Burst Bubbles," International Finance, Wiley Blackwell, vol. 9(1), pages 87-107, May.
    4. Hommes,Cars, 2015. "Behavioral Rationality and Heterogeneous Expectations in Complex Economic Systems," Cambridge Books, Cambridge University Press, number 9781107564978.
    5. Hommes, Cars, 2011. "The heterogeneous expectations hypothesis: Some evidence from the lab," Journal of Economic Dynamics and Control, Elsevier, vol. 35(1), pages 1-24, January.
    6. William A. Brock & Cars H. Hommes, 1997. "A Rational Route to Randomness," Econometrica, Econometric Society, vol. 65(5), pages 1059-1096, September.
    7. Cars Hommes & Joep Sonnemans & Jan Tuinstra & Henk van de Velden, 2005. "Coordination of Expectations in Asset Pricing Experiments," The Review of Financial Studies, Society for Financial Studies, vol. 18(3), pages 955-980.
    8. Brock, William A. & Hommes, Cars H., 1998. "Heterogeneous beliefs and routes to chaos in a simple asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 22(8-9), pages 1235-1274, August.
    9. Mikhail Anufriev & Cars Hommes, 2012. "Evolutionary Selection of Individual Expectations and Aggregate Outcomes in Asset Pricing Experiments," American Economic Journal: Microeconomics, American Economic Association, vol. 4(4), pages 35-64, November.
    10. William A. Brock & Cars H. Hommes, 2001. "A Rational Route to Randomness," Chapters, in: W. D. Dechert (ed.), Growth Theory, Nonlinear Dynamics and Economic Modelling, chapter 16, pages 402-438, Edward Elgar Publishing.
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    Citations

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    Cited by:

    1. Sarah Mignot & Fabio Tramontana & Frank Westerhoff, 2021. "Speculative asset price dynamics and wealth taxes," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 44(2), pages 641-667, December.
    2. Bazzana, Davide & Colturato, Michele & Savona, Roberto, 2023. "Learning about unprecedented events: Agent-based modelling and the stock market impact of COVID-19," Finance Research Letters, Elsevier, vol. 56(C).

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    More about this item

    Keywords

    Boom-bust cycles; Expectation formation and learning; Interest rate policies;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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