Abstract
This paper provides an explanation for the generation of Bubbles in financial markets with heterogeneous agents. We present a game theoretical model that formalises the interactions between two different types of investors: noise traders and fundamental traders, forming their respective expectations on the basis of different rational investment strategies. The model also provides an interpretation framework for periods of euphoria followed by sudden collapse in stock prices. The main predictions of this work are robustly supported by an empirical analysis conducted on a monthly historical time series taken from the S&P500 index, starting from 1954 up to 2019.
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