Bubbles and Market Crashes

Michael Youssefmir, Bernardo A. Huberman, and Tad Hogg
Dynamics of Computation Group
Xerox Palo Alto Research Center
Palo Alto, CA 94304
hogg@parc.xerox.com




Abstract

We present a dynamical theory of asset price bubbles that exhibits the appearance of bubbles and their subsequent crashes. We show that when speculative trends dominate over fundamental beliefs, bubbles form, leading to the growth of asset prices away from their fundamental value. This growth makes the system increasingly susceptible to any exogenous shock, thus eventually precipitating a crash. We also present computer experiments which in their aggregate behavior confirm the predictions of the theory.
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