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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Original Publication URL: http://dx.doi.org/10.1111/1467-937X.00066

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
ePrint ID: 32985
Date Deposited: 21 Jun 2007
Last Modified: 28 Mar 2014 15:26
Projects:
Economic fluctuation and information aggregation
Funded by: ESRC (H52427002794)
1 September 1994 to 30 August 1998
URI: http://eprints.soton.ac.uk/id/eprint/32985

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