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Shakeouts And Market Crashes

  • Alessandro Barbarino
  • Boyan Jovanovic

This article provides a microfoundation for the rise in optimism that seems to precede market crashes. Small, young markets are more likely to experience stock-price run-ups and crashes. We use a Zeira-Rob type of model in which demand size is uncertain. Optimism then grows rationally if traders' prior distribution over market size has a decreasing hazard. Such prior beliefs are appropriate if most new markets are duds and only a few reach a large size. The crash occurs when capacity outstrips demand. As an illustration, for the period 1971-2001 we fit the model to the Telecom sector. Copyright 2007 by the Economics Department Of The University Of Pennsylvania And Osaka University Institute Of Social And Economic Research Association.

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Article provided by Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association in its journal International Economic Review.

Volume (Year): 48 (2007)
Issue (Month): 2 (05)
Pages: 385-420

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Handle: RePEc:ier:iecrev:v:48:y:2007:i:2:p:385-420
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  1. Boyan Jovanovic & Peter L. Rousseau, 2000. "Technology and the Stock Market: 1885-1998," Vanderbilt University Department of Economics Working Papers 0042, Vanderbilt University Department of Economics.
  2. Zeira, Joseph, 1999. "Informational overshooting, booms, and crashes," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 237-257, February.
  3. Horvath, Michael & Schivardi, Fabiano & Woywode, Michael, 2001. "On industry life-cycles: delay, entry, and shakeout in beer brewing," International Journal of Industrial Organization, Elsevier, vol. 19(7), pages 1023-1052, July.
  4. Jovanovic, Boyan & MacDonald, Glenn M, 1994. "The Life Cycle of a Competitive Industry," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 322-47, April.
  5. Rob, Rafael, 1991. "Learning and Capacity Expansion under Demand Uncertainty," Review of Economic Studies, Wiley Blackwell, vol. 58(4), pages 655-75, July.
  6. Markus K Brunnermeier, 2002. "Bubbles and Crashes," FMG Discussion Papers dp401, Financial Markets Group.
  7. Michele Boldrin & David K. Levine, 2000. "Growth cycles and market crashes," Staff Report 279, Federal Reserve Bank of Minneapolis.
  8. Zeira, Joseph, 1987. "Investment as a Process of Search," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 204-10, February.
  9. Caplin, A. & Leahy, J., 1992. "Business as Usual, Market Crashes, and Wisdom after the Fact," Harvard Institute of Economic Research Working Papers 1594, Harvard - Institute of Economic Research.
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