Psychological Determinants of Occurrence and Magnitude of Market Crashes

This paper essentially concludes that anticipation of endowment drops amplify  the magnitude of  market crashes.

Abstract (Via SSRN)

We simulate the Dynamic Stochastic General Equilibrium model of Mehra-Prescott  to establish the link between the anticipation of endowment drops (for instance a recession) and sudden market crashes. Contrary to the commonly accepted view that those crashes are solely driven by large drops in endowments at the time they occur, the simulation shows that: 1- a large and subjective anticipation of an endowment drop amplifies the magnitude of the crash next period without permanent effects, and 2- there always exists an upper-bound on the maximal anticipation of the drop so that the crash magnitude next period remains constant regardless of the drop level. Those findings are independent of the risk aversion of agents, and of the formation process of the anticipation.

Click Here To Read About The Psychological Determinants of Occurrence and Magnitude of Market Crashes

About Miguel Barbosa

I run this site.

12. August 2009 by Miguel Barbosa
Categories: Curated Readings, Finance & Investing | Leave a comment

Leave a Reply

Required fields are marked *