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Bubbles and Crashes in a Behavioural Finance Model

  • De Grauwe, Paul


    (University of Leuven)

  • Grimaldi, Marianna


    (Research Department, Central Bank of Sweden)

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    We develop a simple model of the exchange rate in which agents optimize their portfolio and use different forecasting rules. They check the profitability of these rules ex post and select the more profitable one. This model produces two kinds of equilibria, a fundamental and a bubble one. In a stochastic environment the model generates a complex dynamics in which bubbles and crashes occur at unpredictable moments. We contrast these "behavioural" bubbles with "rational" bubbles.

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    Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 164.

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    Length: 44 pages
    Date of creation: 01 May 2004
    Date of revision:
    Handle: RePEc:hhs:rbnkwp:0164
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    Sveriges Riksbank, SE-103 37 Stockholm, Sweden

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    1. Brunnermeier, Markus K., 2001. "Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding," OUP Catalogue, Oxford University Press, number 9780198296980, December.
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    3. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
    4. Evans, Martin D. & Lyons, Richard K., 1999. "Order Flow and Exchange Rate Dynamics," Research Program in Finance, Working Paper Series qt0dh1c16w, Research Program in Finance, Institute for Business and Economic Research, UC Berkeley.
    5. Eric van Wincoop & Philippe Bacchetta, 2004. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?," Econometric Society 2004 North American Winter Meetings 628, Econometric Society.
    6. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
    7. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
    8. Wei, S.J. & Kim, J., 1999. "The Big Players in the Foreign Exchange Market: Do They Trade on Information or Noise?," Papers 5, Chicago - Graduate School of Business.
    9. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
    10. Mordecai Kurz & Maurizio Motolese, 1999. "Endogenous Uncertainty and Market Volatility," Working Papers 1999.27, Fondazione Eni Enrico Mattei.
    11. Taylor, Mark P. & Allen, Helen, 1992. "The use of technical analysis in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 11(3), pages 304-314, June.
    12. Thomas Lux & D. Sornette, 1999. "On Rational Bubbles and Fat Tails," Papers cond-mat/9910141,
    13. Lui, Yu-Hon & Mole, David, 1998. "The use of fundamental and technical analyses by foreign exchange dealers: Hong Kong evidence," Journal of International Money and Finance, Elsevier, vol. 17(3), pages 535-545, June.
    14. Benoit Mandelbrot, 1963. "The Variation of Certain Speculative Prices," The Journal of Business, University of Chicago Press, vol. 36, pages 394.
    15. Menkhoff, Lukas, 1997. "Examining the Use of Technical Currency Analysis," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 2(4), pages 307-18, October.
    16. Carl Chiarella & Roberto Dieci & Laura Gardini, 2001. "Speculative Behaviour and Complex Asset Price Dynamics," Research Paper Series 49, Quantitative Finance Research Centre, University of Technology, Sydney.
    17. Charles Engel & James C. Morley, 2001. "The Adjustment of Prices and the Adjustment of the Exchange Rate," NBER Working Papers 8550, National Bureau of Economic Research, Inc.
    18. Blanchard, Olivier Jean, 1979. "Speculative bubbles, crashes and rational expectations," Economics Letters, Elsevier, vol. 3(4), pages 387-389.
    19. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
    20. Kenneth A. Froot & Jeffrey A. Frankel, 1986. "Interpreting Tests of Forward Discount Bias Using Survey Data on Exchange Rate Expectations," NBER Working Papers 1963, National Bureau of Economic Research, Inc.
    21. Isard,Peter, 1995. "Exchange Rate Economics," Cambridge Books, Cambridge University Press, number 9780521460477, November.
    22. Isard,Peter, 1995. "Exchange Rate Economics," Cambridge Books, Cambridge University Press, number 9780521466004, November.
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