Loss aversion and market crashes

Loss Aversion, Asymmetric Market Comovements, and the Home Bias

Loss aversion has been used to explain why a high equity premium might be consistent with plausible levels of risk aversion. The intuition is that the different utility impact of wealth gains and losses leads loss-averse investors to behave similarly to investors with high risk aversion. But if so, should these agents not perceive larger gains from international diversification than standard ex...

Bias and Loss Aversion in the Market for Autos

Bubbles and Market Crashes

We present a dynamical theory of asset price bubbles that exhibits the appearance of bubbles and their subsequent crashes. We show that when speculative trends dominate over fundamental beliefs, bubbles form, leading to the growth of asset prices away from their fundamental value. This growth makes the system increasingly susceptible to any exogenous shock, thus eventually precipitating a crash...

Liquidity and Market Crashes

In this paper, we develop an equilibrium model for stock market liquidity and its impact on asset prices when participation in the market is costly. We show that, even when agents’ trading needs are perfectly matched, costly participation prevents them from synchronizing their trades, which gives rise to the endogenous need for liquidity. Moreover, the endogenous liquidity need, when it occurs,...

Shakeouts and Market Crashes

Stock-market crashes tend to follow run-ups in prices. These episodes look like bubbles that gradually inflate and then suddenly burst. We show that such bubbles can form in a Zeira-Rob type of model in which demand size is uncertain. Two conditions are sufficient for this to happen: A declining hazard rate in the prior distribution over market size and a positively sloped supply of capital to ...