Abstract
This study proposes a rational expectation equilibrium model of crashes in an economy with information asymmetry and loss averse speculators. We obtain a state-dependent linear optimal trading strategy, which makes the equilibrium price tractable for the first time in such an economy. The model predicts nonlinear market depth and the fact that small shocks to fundamentals (e.g., supply or informational shocks) can cause abrupt price movements. We demonstrate that short-sale constraints intensify asset price collapses relative to upward movements. The model also generates contagion between uncorrelated assets. These results reflect the main puzzling features observed during market crashes, namely abrupt and asymmetric price movements, not driven by major news events, coupled with a spillover effect between unrelated markets.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
