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http://ssrn.com/abstract=146437
 
 

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Rational Panics and Stock Market Crashes


Gadi Barlevy


Federal Reserve Bank of Chicago; National Bureau of Economic Research (NBER); Institute for the Study of Labor (IZA)

Pietro Veronesi


University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

August 2000

CRSP Working Paper No. 483

Abstract:     
This paper offers an explanation for crashes in the stock market which focuses on the role of rational but uninformed traders. We show that uninformed traders can precipitate a price crash because as prices decline, they reasonably surmise that better informed traders could have received negative information, which leads them to reduce their own demand for assets driving the price of stocks even lower. We also show the model yields several implications, such as the fact that crashes can occur even when the fundamental values of assets are strong, and that the magnitude of the crash depends on the fraction of uninformed investors and the amount of unsophisticated passive investing present in the market. Given increasing participation among uninformed traders and the growing popularity of aggressive trading in recent years, we conclude markets today might remain vulnerable to crashes that may be as severe as those which occurred in the past, in contrast with some of the conventional wisdom that argues such severe crashes have become less likely.

Note: Previously titled, ""On the possibility of Stock Market Crashes in the Absence of Portolio Insurance".

Number of Pages in PDF File: 27

JEL Classification: C14, D82, D84

working papers series


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Date posted: February 12, 1999  

Suggested Citation

Barlevy, Gadi and Veronesi, Pietro, Rational Panics and Stock Market Crashes (August 2000). CRSP Working Paper No. 483. Available at SSRN: http://ssrn.com/abstract=146437 or http://dx.doi.org/10.2139/ssrn.146437

Contact Information

Gadi Barlevy (Contact Author)
Federal Reserve Bank of Chicago ( email )
230 South LaSalle Street
Chicago, IL 60604
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Institute for the Study of Labor (IZA)
P.O. Box 7240
Bonn, D-53072
Germany
Pietro Veronesi
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-6348 (Phone)
773-702-0458 (Fax)
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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