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From Rational Bubbles to Crashes by Sornette, D.; Malevergne, Y. is a scholarly article available to read on EtoBox.

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We study and generalize in various ways the model of rational expectation (RE) bubbles introduced by Blanchard and Watson in the economic literature. First, bubbles are argued to be the equivalent of Goldstone modes of the fundamental rational pricing equation, associated with the symmetry-breaking introduced by non-vanishing dividends. Generalizing bubbles in terms of multiplicative stochastic maps, we summarize the result of Lux and Sornette that the no-arbitrage condition imposes that the tail of the return distribution is hyperbolic with an exponent mu<1. We then extend the RE bubble model to arbitrary dimensions d and, with the renewal theory for products of random matrices applied to stochastic recurrence equations, we extend the theorem of Lux and Sornette to demonstrate that the tails of the unconditional distributions follow power laws, with the same asymptotic tail exponent mu<1 for all assets. Two extensions (the crash hazard rate model and the non-stationary growth rate model) of the RE bubble model provide ways of reconciliation with the stylized facts of financial data. The later model allows for an understanding of the breakdown of the fundamental valuation formula a

Author

Sornette, D.; Malevergne, Y.

Published

2001

Language

EN