Bubbles and Crashes in a Behavioural Finance Model
Paul De Grauwe
London School of Economics & Political Science (LSE); CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Centre for Economic Policy Research (CEPR)
Monetary Policy Division Sveriges Riksbank
CESifo Working Paper Series No. 1194
Riksbank Working Paper No. 164/Riksbank Research Paper Series No. 7
We develop a simple model of the exchange rate in which agents optimize their portfolio and use different forecasting rules. They check the profitability of these rules ex post and select the more profitable one. This model produces two kinds of equilibria, a fundamental and a bubble one. In a stochastic environment the model generates a complex dynamics in which bubbles and crashes occur at unpredictable moments. We contrast these behavioural bubbles with rational bubbles.
Number of Pages in PDF File: 45
Keywords: exchange rate, bounded rationality, heterogeneous agents, bubbles and crashes, complex dynamics
JEL Classification: F31, F41, G10working papers series
Date posted: June 1, 2004
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