Bubbles and Crashes in a Behavioural Finance Model

45 Pages Posted: 1 Jun 2004

See all articles by Paul De Grauwe

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)

Marianna Grimaldi

Monetary Policy Division Sveriges Riksbank

Date Written: May 2004

Abstract

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.

Keywords: exchange rate, bounded rationality, heterogeneous agents, bubbles and crashes, complex dynamics

JEL Classification: F31, F41, G10

Suggested Citation

De Grauwe, Paul and Grimaldi, Marianna, Bubbles and Crashes in a Behavioural Finance Model (May 2004). CESifo Working Paper Series No. 1194; Riksbank Working Paper No. 164/Riksbank Research Paper Series No. 7. Available at SSRN: https://ssrn.com/abstract=553961

Paul De Grauwe (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Marianna Grimaldi

Monetary Policy Division Sveriges Riksbank ( email )

S-103 37 Stockholm
Sweden

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