Market crashes and informational avalanches


Lee, I.H. (1998) Market crashes and informational avalanches Review of Economic Studies, 65, (4), pp. 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
Digital Object Identifier (DOI): doi:10.1111/1467-937X.00066
ISSNs: 0034-6527 (print)
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ePrint ID: 32985
Date :
Date Event
1998Published
Date Deposited: 21 Jun 2007
Last Modified: 16 Apr 2017 22:18
Further Information:Google Scholar
URI: http://eprints.soton.ac.uk/id/eprint/32985

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