Market crashes and informational avalanches
Lee, I.H. (1998) Market crashes and informational avalanches. Review of Economic Studies, 65, (4), 741-759. (doi:10.1111/1467-937X.00066).
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Description/Abstract
This paper analyses a security market with transaction costs and a sequential trading structure. Transaction costs may prevent many traders from revealing their private information if they trade in a sequential fashion. Due to the information aggregation failure, hidden information gets accumulated in the market which may be revealed by a small trigger, yielding a high volatility in the absence of an accompanying event. The paper first characterizes the optimal trading strategy of the agent which constitute the unique equilibrium. Further properties of the price sequence are obtained using the concepts of informational cascade and informational avalanche.
The results are applied to the explanation of market crashes. In particular, the dynamics of market crashes are illustrated as evolving through the following four phases: (1) boom; (2) euphoria; (3) trigger; and (4) panic; where the euphoria corresponds to the informational cascade and the panic corresponds to the informational avalanche.
| Item Type: | Article |
|---|---|
| Related URLs: | |
| Subjects: | H Social Sciences > HF Commerce H Social Sciences > HG Finance H Social Sciences > HB Economic Theory |
| Divisions: | University Structure - Pre August 2011 > School of Social Sciences > Economics |
| Item ID: | 32985 |
| Date Deposited: | 21 Jun 2007 |
| Last Modified: | 01 Jun 2011 04:21 |
| Contributors: | Lee, I.H. (Author) |
| Date: | 1998 |
| Status: | Published |
| Contact Email Address: | ihl@soton.ac.uk |
| URI: | http://eprints.soton.ac.uk/id/eprint/32985 |
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