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Bubblesandcrashes:Gradientdynamicsinfinancial markets

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  • Friedman, Daniel
  • Abraham, Ralph

Abstract

Fund managers respond to the payoff gradient by continuously adjusting leverage in our analytic and simulation models. The base model has a stable equilibrium with classic properties. However, bubbles and crashes occur in extended models incorporating an endogenous market risk premium based on investors' historical losses and constant-gain learning. When losses have been small for a long time, asset prices inflate as fund managers increase leverage. Then slight losses can trigger a crash, as a widening risk premium accelerates deleveraging and asset price declines.

Suggested Citation

  • Friedman, Daniel & Abraham, Ralph, 2008. "Bubblesandcrashes:Gradientdynamicsinfinancial markets," Santa Cruz Department of Economics, Working Paper Series qt3905j8kq, Department of Economics, UC Santa Cruz.
    • Handle: RePEc:cdl:ucscec:qt3905j8kq
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    References listed on IDEAS

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    Cited by:

    1. Feldman, Todd, 2010. "Portfolio manager behavior and global financial crises," Journal of Economic Behavior & Organization, Elsevier, vol. 75(2), pages 192-202, August.

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