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Rational Panics, Absorbing Regime Switching and Stock Market

  • Dengta CHEN
  • Yinggang ZHOU
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    A government policy regarding the reduction of state shares in state-owned enterprises (SOE) triggered a crash in the Chinese stock market. The sus- tained depression even after policy adjustments constitutes a puzzle— the so called “state-share paradox.”The empirical evidence shows that the sustained depression is supported by a regime switching model with an absorbing state. The theoretical explanation developed in this paper arises from the concept of rational panics, which generates an inverted-S actual demand curve and gives rise to potential multiple equilibria. Rational panics hypothesis in this paper suggests that the dual pricing system and the quota on the overall stock supply represent major policy failures

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    Paper provided by Econometric Society in its series Econometric Society 2004 Far Eastern Meetings with number 680.

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    Date of creation: 11 Aug 2004
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    Handle: RePEc:ecm:feam04:680
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    1. Basu, Kaushik & Genicot, Garance & Stiglitz, Joseph E., 2000. "Unemployment and Wage Rigidity When Labor Supply Is a Household Decision," Working Papers 00-10, Cornell University, Center for Analytic Economics.
    2. Gerard Gennotte and Hayne Leland., 1989. "Market Liquidity, Hedging and Crashes," Research Program in Finance Working Papers RPF-192, University of California at Berkeley.
    3. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
    4. Gadi Barlevy & Pietro Veronesi, 2000. "Rational Panics and Stock Market Crashes," CRSP working papers 483, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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