The Invisible Hand and the Rational Agent are Behind Bubbles and Crashes

20 Pages Posted: 17 Jan 2016

Date Written: January 15, 2016

Abstract

The substantial turmoil created by both 2000 dot-com crash and 2008 subprime crisis has fueled the belief that the two classical paradigms of economics, which are the invisible hand and the rational agent, are not appropriate to describe market dynamics and should be abandoned at the benefit of alternative new theoretical concepts. At odd with such a view, using a simple model of choice dynamics from sociophysics, the invisible hand and the rational agent paradigms are given a new legitimacy. Indeed, it is sufficient to introduce the holding of a few intermediate mini market aggregations by agents sharing their own private information, to recenter the invisible hand and the rational agent at the heart of market self regulation including the making of bubbles and their subsequent crashes. In so doing, an elasticity is discovered in the market efficiency mechanism due to the existence of agents anticipation. This elasticity is found to create spontaneous bubbles, which are rationally founded, and at the same time, it provokes crashes when the limit of elasticity is reached. Although the findings disclose a path to put an end to the bubble-crash phenomena, it is argued to be rationality not feasible.

Keywords: invisible hand, rational agent, bubbles, crashes, sociophysics, choice dynamics

JEL Classification: D78, D81, D82, E10

Suggested Citation

Galam, Serge, The Invisible Hand and the Rational Agent are Behind Bubbles and Crashes (January 15, 2016). Available at SSRN: https://ssrn.com/abstract=2716200 or http://dx.doi.org/10.2139/ssrn.2716200

Serge Galam (Contact Author)

Sciences Po and CNRS ( email )

98 Rue de l'Université
Paris, 75007
France

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