Bubbles and Crashes

TitleBubbles and Crashes
Publication TypeJournal Article
Year of Publication2003
AuthorsAbreu D, Brunnermeier MK
Keywordsbehavioral finance, bubbles, crashes, limits to arbitrage, market timing, synchronization, temporal coordination, ‘overreaction’
AbstractWe 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. This synchronization problem together with the individual incentive to time the market results 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.