IDEAS home Printed from
MyIDEAS: Login to save this paper or follow this series

Endogenous versus exogenous origins of financial rallies and crashes in an agent-based model with Bayesian learning and imitation

  • Georges Harras

    (Department of Management, Technology and Economics, ETH Zurich)

  • Didier Sornette

    (Department of Management, Technology and Economics, ETH Zurich and Swiss Finance Institute)

Registered author(s):

    We present a simple agent-based model to study how the proximate triggering factor of a crash or a rally might relate to its fundamental mechanism, and vice versa. Our agents form opinions and invest, based on three sources of information, (i) public information, i.e. news, (ii) information from their “friendship” network, promoting imitation and (iii) private information. Agents use Bayesian learning to adapt their strategy according to the past relevance of the three sources of information. We find that rallies and crashes occur as amplifications of random lucky or unlucky streak of news, due to the feedback of these news on the agents’ strategies into collective transient herding regimes. These ingredients provide a simple mechanism for the excess volatility documented in financial markets. Paradoxically, it is the attempt for investors to learn the level of relevance of the news on the price formation which leads to a dramatic amplification of the price volatility due to their collective search for the “truth”. A positive feedback loop is created by the two dominating mechanisms (Bayesian learning and imitation) which, by reinforcing each other, result in rallies and crashes. The model offers a simple reconciliation of the two opposite (herding versus fundamental) proposals for the origin of crashes within a single framework and justifies the existence of two populations in the distribution of returns, exemplifying the concept that rallies and crashes are qualitatively different from the rest of the price moves.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL:
    Download Restriction: no

    Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 08-16.

    in new window

    Length: 40 pages
    Date of creation:
    Date of revision:
    Handle: RePEc:chf:rpseri:rp0816
    Contact details of provider: Web page:

    More information through EDIRC

    No references listed on IDEAS
    You can help add them by filling out this form.

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:chf:rpseri:rp0816. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marilyn Barja)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.