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Informational overshooting, booms and crashes

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  • Joseph Zeira

Abstract

This paper offers an informational explanation to stock markets' booms and crashes. This explanation builds on the idea of 'informational overshooting': if market fundamentals change for an unknown period of time, prices experience a boom, which ends in a crash, due to informational dynamics. The paper then shows that 'informational overshooting' occurs when the market expands to a new capacity, which is unknown until it is reached. The paper presents two examples for such expansions, one due to increased productivity and one due to entry of new investors to the stock market. One implication is that financial liberalizations tend to be followed by booms and crashes.

Suggested Citation

  • Joseph Zeira, 2000. "Informational overshooting, booms and crashes," Proceedings, Federal Reserve Bank of San Francisco, issue Apr.
  • Handle: RePEc:fip:fedfpr:y:2000:i:apr:x:1
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    File URL: http://www.frbsf.org/economics/conferences/000421/papers/Boom.pdf
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    References listed on IDEAS

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    1. Barsky, Robert B. & Long, J. Bradford De, 1990. "Bull and Bear Markets in the Twentieth Century," The Journal of Economic History, Cambridge University Press, vol. 50(02), pages 265-281, June.
    2. Garber, Peter M, 1990. "Famous First Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 35-54, Spring.
    3. Mayer, Colin, 1988. "New issues in corporate finance," European Economic Review, Elsevier, vol. 32(5), pages 1167-1183, June.
    4. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
    5. Mayshar, Joram, 1979. "Transaction Costs in a Model of Capital Market Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 87(4), pages 673-700, August.
    6. Benjamin M. Friedman & David I. Laibson, 1989. "Economic Implications of Extraordinary Movements in Stock Prices," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(2), pages 137-190.
    7. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, January.
    8. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-738, August.
    9. Zeira, Joseph, 1987. "Investment as a Process of Search," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 204-210, February.
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    11. Blanchard, Olivier Jean, 1979. "Speculative bubbles, crashes and rational expectations," Economics Letters, Elsevier, vol. 3(4), pages 387-389.
    12. Romer, David, 1993. "Rational Asset-Price Movements without News," American Economic Review, American Economic Association, vol. 83(5), pages 1112-1130, December.
    13. Rafael Rob, 1991. "Learning and Capacity Expansion under Demand Uncertainty," Review of Economic Studies, Oxford University Press, vol. 58(4), pages 655-675.
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    More about this item

    Keywords

    Stock market;

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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