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Bubbles And Crashes: Optimism, Trend Extrapolation And Panic

Author

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  • FRANK WESTERHOFF

    (Department of Economics, University of Osnabrueck, Rolandstrasse 8, D-49069 Osnabrueck, Germany)

Abstract

The observation that large drawdowns are outliers suggests that a special mechanism may be responsible for large crashes. We develop a simple model with heterogeneous interacting agents which follow technical and fundamental trading rules to determine their orders. Although the chartists are optimistic most of the time, they panic if prices drop sharply. Our main finding is that the selling impact due to a panic attack may be so large that it directly leads to the next panic attack. Such behavior generates temporal correlation in prices, i.e., causes large drawdowns.

Suggested Citation

  • Frank Westerhoff, 2003. "Bubbles And Crashes: Optimism, Trend Extrapolation And Panic," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 6(08), pages 829-837.
    • Handle: RePEc:wsi:ijtafx:v:06:y:2003:i:08:n:s0219024903002237
    DOI: 10.1142/S0219024903002237
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    Citations

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    Cited by:

    1. Sansone, Alessandro & Garofalo, Giuseppe, 2007. "Asset price dynamics in a financial market with heterogeneous trading strategies and time delays," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 382(1), pages 247-257.
    2. Ma, Rong & Zhang, Yin & Li, Honggang, 2017. "Traders’ behavioral coupling and market phase transition," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 486(C), pages 618-627.

    More about this item

    Keywords

    Bubbles and crashes; drawdowns and drawups; technical and fundamental analysis; optimism and panic; JEL classification code D84; G14;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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