The Financial Crisis as a Stock Market Overshooting Phenomenon: A Theoretical Analysis
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.
Volume (Year): 82 (2009)
Issue (Month): 12 (December)
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