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Bubbles and crashes with partially sophisticated investors

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  • Milo Bianchi

    (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales (EHESS) - École des Ponts ParisTech (ENPC) - École normale supérieure [ENS] - Paris, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)

  • Philippe Jehiel

    (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales (EHESS) - École des Ponts ParisTech (ENPC) - École normale supérieure [ENS] - Paris, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, UCL - University College London - London's Global University - University College of London (UCL))

Abstract

We consider a purely speculative market with finite horizon and complete information. We introduce partially sophisticated investors, who know the average buy and sell strategies of other traders, but lack a precise understanding of how these strategies depend on the history of trade. In this setting, it is common knowledge that the market is overvalued and bound to crash, but agents hold different expectations about the date of the crash. We define conditions for the existence of equilibrium bubbles and crashes, characterize their structure, and show how bubbles may last longer when the amount of fully rational traders increases.

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Bibliographic Info

Paper provided by HAL in its series PSE Working Papers with number halshs-00586045.

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Date of creation: Oct 2008
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Handle: RePEc:hal:psewpa:halshs-00586045

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Keywords: speculative bubbles ; crashes ; bounded rationality;

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  1. De Long, J Bradford, et al, 1990. " Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance, American Finance Association, vol. 45(2), pages 379-95, June.
  2. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
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  5. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
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  7. Hirshleifer, David, 2001. "Investor Psychology and Asset Pricing," MPRA Paper 5300, University Library of Munich, Germany.
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  9. Harrison Hong & Jose Scheinkman & Wei Xiong, 2005. "Asset Float and Speculative Bubbles," Levine's Bibliography 122247000000000861, UCLA Department of Economics.
  10. Nagel, Rosemarie, 1995. "Unraveling in Guessing Games: An Experimental Study," American Economic Review, American Economic Association, vol. 85(5), pages 1313-26, December.
  11. Bianchi, Milo & Jehiel, Philippe, 2010. "Bubbles and Crashes with Partially Sophisticated Investors," Economics Papers from University Paris Dauphine 123456789/5361, Paris Dauphine University.
  12. Veldkamp, Laura L., 2005. "Slow boom, sudden crash," Journal of Economic Theory, Elsevier, vol. 124(2), pages 230-257, October.
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  18. John H. Cochrane, 2002. "Stocks as Money: Convenience Yield and the Tech-Stock Bubble," NBER Working Papers 8987, National Bureau of Economic Research, Inc.
  19. Bhattacharya, Utpal & Galpin, Neal & Ray, Rina & Yu, Xiaoyun, 2009. "The Role of the Media in the Internet IPO Bubble," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(03), pages 657-682, June.
  20. Harrison Hong & Jeremy C. Stein, 2007. "Disagreement and the Stock Market," Journal of Economic Perspectives, American Economic Association, vol. 21(2), pages 109-128, Spring.
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Cited by:
  1. Jakub Steiner & Colin Stewart, 2012. "Price Distortions in High-Frequency Markets," Discussion Papers 1549, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Milo Bianchi & Philippe Jehiel, 2008. "Bubbles and crashes with partially sophisticated investors," PSE Working Papers halshs-00586045, HAL.

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