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Irrational Exuberance and Herding in Financial Markets

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  • Christopher Boortz

Abstract

In the context of a two-state, two-trader financial market herd model introduced by Avery and Zemsky (1998) we investigate how informational ambiguity in conjunction with waves of optimism and pessimism affect investor behavior, social learning and price dynamics. Without ambiguity, neither herding nor contrarianism is possible. If there is ambiguity and agents have invariant ambiguity preferences, only contrarianism is possible. If on the other hand ambiguity is high and traders become overly exuberant (or desperate) as the asset price surges (or plummets), we establish that investor herding may drive prices away from fundamentals with economically relevant probability.

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  • Christopher Boortz, 2016. "Irrational Exuberance and Herding in Financial Markets," SFB 649 Discussion Papers SFB649DP2016-016, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    • Handle: RePEc:hum:wpaper:sfb649dp2016-016
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    More about this item

    Keywords

    Social Learning; Herding; Contrarianism; (Partial) Informational Cascade; Ambiguity; Choquet Expected Utility; NEO-Additive Capacities;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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