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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. Caplin, Andrew & Leahy, John, 1994. "Business as Usual, Market Crashes, and Wisdom after the Fact," American Economic Review, American Economic Association, vol. 84(3), pages 548-65, June.
  2. Dilip Abreu & Markus K. Brunnermeier, 2002. "Bubbles and crashes," LSE Research Online Documents on Economics 24905, London School of Economics and Political Science, LSE Library.
  3. Michele Boldrin & David K. Levine, 1999. "Growth Cycles and Market Crashes," Levine's Working Paper Archive 2028, David K. Levine.
  4. Jovanovic, B. & MacDonald, G.M., 1992. "The Life-Cycle of Competitive Industry," Papers 92-09, Rochester, Business - Financial Research and Policy Studies.
  5. Zeira, Joseph, 1993. "Informational Overshooting, Booms and Crashes," CEPR Discussion Papers 823, C.E.P.R. Discussion Papers.
  6. 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.
  7. 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.
  8. Rob, Rafael, 1991. "Learning and Capacity Expansion under Demand Uncertainty," Review of Economic Studies, Wiley Blackwell, vol. 58(4), pages 655-75, July.
  9. Zeira, Joseph, 1987. "Investment as a Process of Search," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 204-10, February.
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