Bubbles and Crashes
Dilip Abreu, Markus K. Brunnermeier
Econometrica · 2003 · Volume 71 · Issue 1
Abstract
We present a model in which an asset bubble can persist despite the presence of rational arbitrageurs. The resilience of the bubble stems from the inability of arbitrageurs to temporarily coordinate their selling strategies. Thissynchronization problemtogether with the individual incentive totime the marketresults in the persistence of bubbles over a substantial period. Since the derived trading equilibrium is unique, our model rationalizes the existence of bubbles in a strong sense. The model also provides a natural setting in which news events, by enabling synchronization, can have a disproportionate impact relative to their intrinsic informational content.
Keywords
bubbles, crashes, temporal coordination, synchronization, market timing, ‘overreaction’, limits to arbitrage, behavioral finance
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