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When Are Market Crashes Driven by Speculation?

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  • Patrick Leoni

Abstract

A natural conjecture is that speculative trade disappears when individual beliefs become correct through learning. Sandroni in [22] gives a counterexample in an economy with sunspots. We generalize Sandroni's result by showing that the conjecture holds for economies with complete markets only. We consider a standard finite-horizon General Equilibrium model with complete markets, where uncertainty is represented by fluctuations in individual endowments. Individual beliefs are formed through arbitrary learning processes, and become eventually correct. We show that along every path of events, equilibrium prices of traded assets converge to rational expectations for the sup-norm. We also give a set of sufficient conditions on beliefs and aggregate endowment leading to market crashes, as in Sandroni [22]. We show that such situations are generically continuous perturbations of rational expectations behaviors when beliefs satisfy a requirement introduced here.

Suggested Citation

  • Patrick Leoni, "undated". "When Are Market Crashes Driven by Speculation?," IEW - Working Papers 197, Institute for Empirical Research in Economics - University of Zurich.
    • Handle: RePEc:zur:iewwpx:197
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    References listed on IDEAS

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    1. Bruno S. Frey & Simon Luechinger & Alois Stutzer, 2007. "Calculating Tragedy: Assessing The Costs Of Terrorism," Journal of Economic Surveys, Wiley Blackwell, vol. 21(1), pages 1-24, February.

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    More about this item

    Keywords

    Asset Pricing; Speculation; Market Crashes;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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