Information Contamination, Market Crashes, and Overshooting

Posted: 21 Oct 2016 Last revised: 18 Oct 2018

See all articles by Jun Aoyagi

Jun Aoyagi

University of California, Berkeley - Department of Economics

Date Written: April 1, 2017

Abstract

This paper provides the model of self-organized stock market crashes with overshooting. Unlike typical macroeconomic and finance models, an economy can experience a boom and bust without any aggregate exogenous shocks nor successive idiosyncratic shocks. Under the boom, the economy spontaneously moves toward a critical point and the crash with overshooting takes place. What matters for this story is the herding behavior of irrational agents and contamination of the price information. Irrational agents exhibit Ss-type behavior under ambiguous situations and this makes a portion of traders suddenly escape from a stock market when the information becomes imprecise enough. This first round escape may lead to the further escape of other traders as well as a tremendous price drop. The model also analyzes how the boom will end and its aftermath: crash with overshooting, stagnation, recovery, and even soft-landing scenario without discrete price drops are considered.

Keywords: Market crises, Information, Ambiguity, Overshooting

JEL Classification: E03, E44, G01, G11, G14

Suggested Citation

Aoyagi, Jun, Information Contamination, Market Crashes, and Overshooting (April 1, 2017). Available at SSRN: https://ssrn.com/abstract=2856211 or http://dx.doi.org/10.2139/ssrn.2856211

Jun Aoyagi (Contact Author)

University of California, Berkeley - Department of Economics ( email )

CA
United States

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