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A theory of asset price booms and busts and the uncertain return to innovation

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  • Satyajit Chatterjee

Abstract

Many observers believe that turbulence in asset prices results from bouts of optimism and pessimism among investors that have little to do with economic reality. While psychology and emotions are no doubt important motivators of human actions, an explanation for asset price booms and busts that ignores the fact that humans are also thinking animals does not seem entirely satisfactory or plausible. In this article, Satyajit Chatterjee presents a counterpoint to the view that ?it?s all psychology.? He reports on a theory of asset price booms and busts that is based entirely on rational decision-making and devoid of psychological elements. The explanation suggests that asset price booms and crashes are most likely to occur when the value of the asset in question depends on an innovation whose full profit potential is initially unknown to investors.

Suggested Citation

  • Satyajit Chatterjee, 2011. "A theory of asset price booms and busts and the uncertain return to innovation," Business Review, Federal Reserve Bank of Philadelphia, issue Q4, pages 1-8.
    • Handle: RePEc:fip:fedpbr:y:2011:i:q4:p:1-8:n:11-10
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    References listed on IDEAS

    as
    1. Zeira, Joseph, 1999. "Informational overshooting, booms, and crashes," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 237-257, February.
    2. Gorton, Gary B., 2010. "Slapped by the Invisible Hand: The Panic of 2007," OUP Catalogue, Oxford University Press, number 9780199734153.
    3. Robert J. Gordon, 2003. "Hi-tech Innovation and Productivity Growth: Does Supply Create Its Own Demand?," NBER Working Papers 9437, National Bureau of Economic Research, Inc.
    4. Joseph Zeira, 2000. "Informational overshooting, booms and crashes," Proceedings, Federal Reserve Bank of San Francisco, issue apr.
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