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Rational Frenzies and Crashes

  • Bulow, Jeremy
  • Klemperer, Paul

Most markets clear through a sequence of sales rather than through a Walrasian auctioneer. Because buyers can decide whether to buy now or later, rather than only now or never, their current 'willingness to pay' is much more sensitive to price than the demand curve is. A consequence is that markets will be extremely sensitive to new information, leading to both 'frenzies,' in which demand feeds on itself, and 'crashes,' in which price drops discontinuously. The paper also shows how a result from static auction theory, the revenue equivalence theorem, can be applied to solve for a dynamic price path. Copyright 1994 by University of Chicago Press.

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Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 102 (1994)
Issue (Month): 1 (February)
Pages: 1-23

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Handle: RePEc:ucp:jpolec:v:102:y:1994:i:1:p:1-23
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  1. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
  2. Myerson, Roger B. & Satterthwaite, Mark A., 1983. "Efficient mechanisms for bilateral trading," Journal of Economic Theory, Elsevier, vol. 29(2), pages 265-281, April.
  3. Welch, Ivo, 1992. " Sequential Sales, Learning, and Cascades," Journal of Finance, American Finance Association, vol. 47(2), pages 695-732, June.
  4. Paul Milgrom & Robert J. Weber, 1981. "A Theory of Auctions and Competitive Bidding," Discussion Papers 447R, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1992. "A Theory of Fads, Fashion, Custom, and Cultural Change in Informational Cascades," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 992-1026, October.
  6. John G. Riley & William Samuelson, 1979. "Optimal Auctions," UCLA Economics Working Papers 152, UCLA Department of Economics.
  7. William Vickrey, 1961. "Counterspeculation, Auctions, And Competitive Sealed Tenders," Journal of Finance, American Finance Association, vol. 16(1), pages 8-37, 03.
  8. Harris, Milton & Raviv, Artur, 1981. "A Theory of Monopoly Pricing Schemes with Demand Uncertainty," American Economic Review, American Economic Association, vol. 71(3), pages 347-65, June.
  9. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
  10. Bulow, Jeremy & Roberts, John, 1989. "The Simple Economics of Optimal Auctions," Journal of Political Economy, University of Chicago Press, vol. 97(5), pages 1060-90, October.
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