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A Behavioral Model of Bubbles and Crashes

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  • Kaizoji, Taisei (kaizoji@icu.ac.jp)

Abstract

The aim of this paper is to provide one potential theoretical explanation for questions how asset bubbles come about, why it persists, and what caused it to burst. We propose a new model of bubbles and crashes. We divide the risky assets into two classes, the bubble asset and the non-bubble asset, and the risk-free asset. Investors are divided into two groups, the rational investors and the noise traders. The rational investors maximize their expected utility of their wealth in the next period. Noise traders maximize their random utility of binary choice: holding the bubble asset and holding the risk-free asst. We demonstrate that noise-traders’ herd behavior, which follows the behavior getting a majority, occurs when the number of noise-traders increases, and their herd behavior gives cause to a bubble, and their momentum trading prolongs bubble. However, rising stock price slows down as the noise-trader’s behavior approaches to a stationary state, so that the price momentum begins to decrease in the second half of bubble. We demonstrate that decreasing the price momentum lead to market crash.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 20352.

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Date of creation: 10 Jan 2010
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Handle: RePEc:pra:mprapa:20352

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Keywords: Bubble; chrash; noise traders; rational investors;

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Citations

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Cited by:
  1. T. Kaizoji & M. Leiss & A. Saichev & D. Sornette, 2011. "Super-exponential endogenous bubbles in an equilibrium model of rational and noise traders," Papers 1109.4726, arXiv.org, revised Mar 2014.
  2. Hüsler, A. & Sornette, D. & Hommes, C.H., 2013. "Super-exponential bubbles in lab experiments: Evidence for anchoring over-optimistic expectations on price," Journal of Economic Behavior & Organization, Elsevier, vol. 92(C), pages 304-316.
  3. Kaizoji, Taisei, 2010. "Carry Trade, Forward Premium Puzzle and Currency Crisis," MPRA Paper 21432, University Library of Munich, Germany.

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