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The invisible hand and the rational agent are behind bubbles and crashes

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  • Serge Galam

Abstract

The substantial turmoil created by both 2000 dot-com crash and 2008 subprime crisis has fueled the belief that the two classical paradigms of economics, which are the invisible hand and the rational agent, are not appropriate to describe market dynamics and should be abandoned at the benefit of alternative new theoretical concepts. At odd with such a view, using a simple model of choice dynamics from sociophysics, the invisible hand and the rational agent paradigms are given a new legitimacy. Indeed, it is sufficient to introduce the holding of a few intermediate mini market aggregations by agents sharing their own private information, to recenter the invisible hand and the rational agent at the heart of market self regulation including the making of bubbles and their subsequent crashes. In so doing, an elasticity is discovered in the market efficiency mechanism due to the existence of agents anticipation. This elasticity is found to create spontaneous bubbles, which are rationally founded, and at the same time, it provokes crashes when the limit of elasticity is reached. Although the findings disclose a path to put an end to the bubble-crash phenomena, it is argued to be rationality not feasible.

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  • Serge Galam, 2016. "The invisible hand and the rational agent are behind bubbles and crashes," Papers 1601.02990, arXiv.org.
    • Handle: RePEc:arx:papers:1601.02990
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    2. Aleksejus Kononovicius, 2017. "Empirical Analysis and Agent-Based Modeling of the Lithuanian Parliamentary Elections," Complexity, Hindawi, vol. 2017, pages 1-15, November.
    3. Gardini, L. & Radi, D. & Schmitt, N. & Sushko, I. & Westerhoff, F., 2022. "Causes of fragile stock market stability," Journal of Economic Behavior & Organization, Elsevier, vol. 200(C), pages 483-498.
    4. Vygintas Gontis & Shlomo Havlin & Aleksejus Kononovicius & Boris Podobnik & H. Eugene Stanley, 2015. "Stochastic model of financial markets reproducing scaling and memory in volatility return intervals," Papers 1507.05203, arXiv.org, revised Oct 2016.
    5. Duarte Queirós, Sílvio M. & Anteneodo, Celia, 2016. "Complexity in quantitative finance and economics," Chaos, Solitons & Fractals, Elsevier, vol. 88(C), pages 1-2.

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