Asset Price Fluctuations, Financial Crises and the Stabilizing Effects of a General Transaction Tax
The deepening of the recent crisis was driven by the simultaneous devaluation of stock wealth, housing wealth and commodity wealth. The potential for this devaluation process had been "built up" during the boom of stock prices, house prices and commodity prices between 2003 and 2007. Hence, this paper sketches the main causes and effects of long swings in asset prices in the context of the current crisis. It is shown that "bull markets" are brought about by upward price runs (i.e., monotonic movements) lasting longer than counter-movements for an extended period of time (and vice versa for "bear markets"). This pattern of asset price dynamics is the result of "trading as usual" on (highly regulated) derivatives exchanges. The most popular trading practices like "technical analysis" contribute significantly to asset price overshooting. These practices strengthened both, the boom of asset prices until mid 2007 as well as their collapse in recent months. A general financial transaction tax would limit the wide fluctuations of stock prices, exchange rates and commodity prices.
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- John H. Cochrane, 1999.
"New facts in finance,"
Federal Reserve Bank of Chicago, issue Q III, pages 36-58.
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