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A Behavioral Model of Bubbles and Crashes

  • Kaizoji, Taisei (

The aim of this paper is to provide one potential theoretical explanation for questions how asset bubbles come about, why it persists, and what caused it to burst. We propose a new model of bubbles and crashes. We divide the risky assets into two classes, the bubble asset and the non-bubble asset, and the risk-free asset. Investors are divided into two groups, the rational investors and the noise traders. The rational investors maximize their expected utility of their wealth in the next period. Noise traders maximize their random utility of binary choice: holding the bubble asset and holding the risk-free asst. We demonstrate that noise-traders’ herd behavior, which follows the behavior getting a majority, occurs when the number of noise-traders increases, and their herd behavior gives cause to a bubble, and their momentum trading prolongs bubble. However, rising stock price slows down as the noise-trader’s behavior approaches to a stationary state, so that the price momentum begins to decrease in the second half of bubble. We demonstrate that decreasing the price momentum lead to market crash.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 20352.

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Date of creation: 10 Jan 2010
Date of revision:
Handle: RePEc:pra:mprapa:20352
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  1. Taisei Kaizoji, 2000. "Speculative bubbles and crashes in stock market: an interacting-agent model of speculative activity," Papers cond-mat/0010263,
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  19. J. Michael Harrison & David M. Kreps, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, Oxford University Press, vol. 92(2), pages 323-336.
  20. Markus K Brunnermeier, 2002. "Bubbles and Crashes," FMG Discussion Papers dp401, Financial Markets Group.
  21. Lux, Thomas, 1995. "Herd Behaviour, Bubbles and Crashes," Economic Journal, Royal Economic Society, vol. 105(431), pages 881-96, July.
  22. Smith, Vernon L & Suchanek, Gerry L & Williams, Arlington W, 1988. "Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets," Econometrica, Econometric Society, vol. 56(5), pages 1119-51, September.
  23. Bruno Biais & Peter Bossaerts, 1998. "Asset Prices and Trading Volume in a Beauty Contest," Review of Economic Studies, Oxford University Press, vol. 65(2), pages 307-340.
  24. George-Marios Angeletos & Guido Lorenzoni & Alessandro Pavan, 2010. "Beauty Contests and Irrational Exuberance: A Neoclassical Approach," Levine's Working Paper Archive 661465000000000237, David K. Levine.
  25. De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
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