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The Financial Crisis as a Stock Market Overshooting Phenomenon: A Theoretical Analysis

  • Fritz Breuss

    (WIFO)

Inspired by Dornbusch's model of exchange rate overshooting we develop a theory of stock market behaviour. The idea is that stock prices overshoot and undershoot their long-run equilibrium values which are determined by the development in the real economy. The overshooting is triggered primarily by a loose monetary policy. The simple macro model consists of three markets the money market, the stock market and the goods market interacting at different speeds of adjustment. The goods market slowly adjusts relative to the money and the stock market. This model can explain some of the major features of the global financial crisis, having its origin in the loose monetary policy in the USA. The three-market model could also help to understand the emergence and consequences of the subprime crisis in the US housing market. Due to the globalised financial investment business the US crisis spread across the whole world, especially Europe and Asia.

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Article provided by WIFO in its journal WIFO-Monatsberichte.

Volume (Year): 82 (2009)
Issue (Month): 12 (December)
Pages: 933-941

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Handle: RePEc:wfo:monber:y:2009:i:12:p:933-941
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  1. Carmen M. Reinhart & Kenneth S. Rogoff, 2008. "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," NBER Working Papers 13882, National Bureau of Economic Research, Inc.
  2. John Moore & Nobuhiro Kiyotaki, . "Credit Cycles," Discussion Papers 1995-5, Edinburgh School of Economics, University of Edinburgh.
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  4. Fritz Breuss & Serguei Kaniovski & Margit Schratzenstaller, 2009. "Macro-economic Effects of the Fiscal Stimulus Measures in Austria," Austrian Economic Quarterly, WIFO, vol. 14(4), pages 205-216, November.
  5. Zeeman, E. C., 1974. "On the unstable behaviour of stock exchanges," Journal of Mathematical Economics, Elsevier, vol. 1(1), pages 39-49, March.
  6. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  7. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  8. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973, April.
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