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Bubbles and Crashes

Princeton Working Paper

41 Pages Posted: 15 Jan 2002  

Dilip Abreu

Princeton University - Department of Economics

Markus K. Brunnermeier

Princeton University - Department of Economics

Date Written: November 2001

Abstract

We present a model in which an asset bubble can persist despite the presence of rational arbitrageurs. The resilience of the bubble stems from the inability of arbitrageurs to temporarily coordinate their selling strategies. This synchronization problem, together with the individual incentive to time the market, results in the persistence of bubbles over a substantial period of time. Since the derived trading equilibrium is unique, our model rationalizes the existence of bubbles in a strong sense. The model also provides a natural setting in which public events, by enabling synchronization, can have a disproportionate impact relative to their intrinsic informational content.

Keywords: Bubbles, Temporal Coordination, Synchronization, Market Timing, Limits to Arbitrage, Behavioral Finance, Dynamic Global Games

JEL Classification: D8, G1

Suggested Citation

Abreu, Dilip and Brunnermeier, Markus K., Bubbles and Crashes (November 2001). Princeton Working Paper. Available at SSRN: https://ssrn.com/abstract=296701 or http://dx.doi.org/10.2139/ssrn.296701

Dilip Abreu

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

Markus Konrad Brunnermeier (Contact Author)

Princeton University - Department of Economics ( email )

Bendheim Center for Finance
Princeton, NJ
United States
609-258-4050 (Phone)
609-258-0771 (Fax)

HOME PAGE: http://www.princeton.edu/¡­markus

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