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Market crashes and informational avalanches

Record type: Article

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.

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Citation

Lee, I.H. (1998) Market crashes and informational avalanches The Review of Economic Studies, 65, (4), pp. 741-759. (doi:10.1111/1467-937X.00066).

More information

Published date: 1998
Organisations: Economics

Identifiers

Local EPrints ID: 32985
URI: http://eprints.soton.ac.uk/id/eprint/32985
ISSN: 0034-6527
PURE UUID: 65e32179-ae75-4fa6-b88b-a69a673b92e9

Catalogue record

Date deposited: 21 Jun 2007
Last modified: 17 Jul 2017 15:54

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Contributors

Author: I.H. Lee

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