Journal Article

Market Crashes and Informational Avalanches

In Ho Lee

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 65, issue 4, pages 741-759
Published in print October 1998 | ISSN: 0034-6527
Published online October 1998 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/1467-937X.00066
Market Crashes and Informational Avalanches

Show Summary Details

Preview

This paper analyses a security market with transaction costs and a sequential trading structure. Transaction costs may prevent many traders from revealing their private information if they trade in a sequential fashion. Due to the information aggregation failure, hidden information gets accumulated in the market which may be revealed by a small trigger, yielding a high volatility in the absence of an accompanying event. The paper first characterizes the optimal trading strategy of the agent which constitute the unique equilibrium. Further properties of the price sequence are obtained using the concepts of informational cascade and informational avalanche.

The results are applied to the explanation of market crashes. In particular, the dynamics of market crashes are illustrated as evolving through the following four phases: (1) boom; (2) euphoria; (3) trigger; and (4) panic; where the euphoria corresponds to the informational cascade and the panic corresponds to the informational avalanche.

Journal Article.  0 words. 

Subjects: Economics

Full text: subscription required

How to subscribe Recommend to my Librarian

Users without a subscription are not able to see the full content. Please, subscribe or login to access all content.