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The Financial Crisis as a Stock Market Overshooting Phenomenon: A Theoretical Analysis

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  • Fritz Breuss

    (WIFO)

Abstract

Inspired by Dornbusch's model of exchange rate overshooting we develop a theory of stock market behaviour. The idea is that stock prices overshoot and undershoot their long-run equilibrium values which are determined by the development in the real economy. The overshooting is triggered primarily by a loose monetary policy. The simple macro model consists of three markets the money market, the stock market and the goods market interacting at different speeds of adjustment. The goods market slowly adjusts relative to the money and the stock market. This model can explain some of the major features of the global financial crisis, having its origin in the loose monetary policy in the USA. The three-market model could also help to understand the emergence and consequences of the subprime crisis in the US housing market. Due to the globalised financial investment business the US crisis spread across the whole world, especially Europe and Asia.

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Bibliographic Info

Article provided by WIFO in its journal WIFO-Monatsberichte.

Volume (Year): 82 (2009)
Issue (Month): 12 (December)
Pages: 933-941

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Handle: RePEc:wfo:monber:y:2009:i:12:p:933-941

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Keywords: Finanzmarktkrise Overshooting;

References

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  1. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, Princeton University Press, edition 1, volume 1, number 8973.
  2. Monacelli, Tommaso, 2006. "New Keynesian Models, Durable Goods and Collateral Constraints," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5916, C.E.P.R. Discussion Papers.
  3. John Moore & Nobuhiro Kiyotaki, . "Credit Cycles," Discussion Papers, Edinburgh School of Economics, University of Edinburgh 1995-5, Edinburgh School of Economics, University of Edinburgh.
  4. Carmen M. Reinhart & Kenneth S. Rogoff, 2014. "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," Annals of Economics and Finance, Society for AEF, vol. 15(2), pages 1065-1188, November.
  5. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262150476, December.
  6. Zeeman, E. C., 1974. "On the unstable behaviour of stock exchanges," Journal of Mathematical Economics, Elsevier, vol. 1(1), pages 39-49, March.
  7. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(6), pages 1161-76, December.
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