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Bubbles and crashes with partially sophisticated investors

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Author Info
Milo Bianchi
Philippe Jehiel

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Abstract

We consider a purely speculative market with .nite 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 di¤erent expectations about the date of the crash. We de.ne 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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Paper provided by PSE (Ecole normale supérieure) in its series PSE Working Papers with number 2008-62.

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Date of creation: 2008
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Handle: RePEc:pse:psecon:2008-62

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