Shakeouts and Market Crashes

36 Pages Posted: 11 Apr 2007

See all articles by Alessandro Barbarino

Alessandro Barbarino

Board of Governors of the Federal Reserve System

Boyan Jovanovic

New York University - Department of Economics

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Abstract

This article provides a microfoundation for the rise in optimism that seems to precede market crashes. Small, young markets are more likely to experience stock-price run-ups and crashes. We use a Zeira-Rob type of model in which demand size is uncertain. Optimism then grows rationally if traders' prior distribution over market size has a decreasing hazard. Such prior beliefs are appropriate if most new markets are duds and only a few reach a large size. The crash occurs when capacity outstrips demand. As an illustration, for the period 1971-2001 we fit the model to the Telecom sector.

Suggested Citation

Barbarino, Alessandro and Jovanovic, Boyan, Shakeouts and Market Crashes. International Economic Review, Vol. 48, No. 2, pp. 385-420, May 2007, Available at SSRN: https://ssrn.com/abstract=979631 or http://dx.doi.org/10.1111/j.1468-2354.2007.00432.x

Alessandro Barbarino

Board of Governors of the Federal Reserve System ( email )

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Boyan Jovanovic (Contact Author)

New York University - Department of Economics ( email )

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New York, NY 10012
United States

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