Book contents
- Frontmatter
- Contents
- Contributors
- Introduction
- PART I DATA: THE PREREQUISITE FOR MANAGING SYSTEMIC RISK
- PART II STATISTICS AND SYSTEMIC RISK
- PART III MEASURING AND REGULATING SYSTEMIC RISK
- PART IV NETWORKS
- PART V SYSTEMIC RISK ANDMATHEMATICAL FINANCE
- PART VI COUNTERPARTY RISK AND SYSTEMIC RISK
- PART VII ALGORITHMIC TRADING
- PART VIII BEHAVIORAL FINANCE: THE PSYCHOLOGICAL DIMENSION OF SYSTEMIC RISK
- 23 Fear, Greed, and Financial Crises: A Cognitive Neurosciences Perspective
- 24 Bubbles, Crises, and Heterogeneous Beliefs
- 25 Systemic Risk and Sentiment
- PART IX REGULATION
- PART X COMPUTATIONAL ISSUES AND REQUIREMENTS
- PART XI ACCOUNTING ISSUES
- References
24 - Bubbles, Crises, and Heterogeneous Beliefs
from PART VIII - BEHAVIORAL FINANCE: THE PSYCHOLOGICAL DIMENSION OF SYSTEMIC RISK
Published online by Cambridge University Press: 05 June 2013
By
Book contents
- Frontmatter
- Contents
- Contributors
- Introduction
- PART I DATA: THE PREREQUISITE FOR MANAGING SYSTEMIC RISK
- PART II STATISTICS AND SYSTEMIC RISK
- PART III MEASURING AND REGULATING SYSTEMIC RISK
- PART IV NETWORKS
- PART V SYSTEMIC RISK ANDMATHEMATICAL FINANCE
- PART VI COUNTERPARTY RISK AND SYSTEMIC RISK
- PART VII ALGORITHMIC TRADING
- PART VIII BEHAVIORAL FINANCE: THE PSYCHOLOGICAL DIMENSION OF SYSTEMIC RISK
- 23 Fear, Greed, and Financial Crises: A Cognitive Neurosciences Perspective
- 24 Bubbles, Crises, and Heterogeneous Beliefs
- 25 Systemic Risk and Sentiment
- PART IX REGULATION
- PART X COMPUTATIONAL ISSUES AND REQUIREMENTS
- PART XI ACCOUNTING ISSUES
- References
Summary
Abstract Heterogeneous beliefs are a widely observed attribute of individuals. This chapter reviews the quickly growing literature that builds on heterogeneous beliefs to explain bubbles, crises, and endogenous risk in financial markets.
The history of financial markets has been dotted with episodes of bubbles, during which market values of assets vastly exceeded reasonable assessments of their fundamental value. Asset price bubbles can lead to severe economic consequences ranging from wasteful over-investment and frenzied trading during booms to devastating financial crises and depressed real economies during busts. Economists have emphasized many aspects of bubbles and crises. Minsky (1974) advocated the view that excessive expansion of bank credit due to optimism can fuel a speculative euphoria and slowly lead the economy to a crisis. Kindleberger (1978) stressed that irrationally optimistic expectations frequently emerge among investors in the late stages of major economic booms and lead firm managers to over-invest, overpromise, and over-leverage, which sow the seeds for an eventual collapse after they fail to deliver on their promises. Shiller (2000) highlighted a host of psychological biases people use in forming a feedback mechanism, through which initial price increases caused by certain initial precipitating factors such as new technology innovations feed back into even higher asset prices through increased investor confidence and expectations. Allen and Gale (2007) focused on agency problems of professional managers who actively seek unwarranted risk, which leads to bubbles and crises.
- Type
- Chapter
- Information
- Handbook on Systemic Risk , pp. 663 - 713Publisher: Cambridge University PressPrint publication year: 2013
References
and (2002). Synchronization risk and delayed arbitrage. Journal of Financial Economics 66 341–360.CrossRefGoogle Scholar
, , and (2009). Fragility of asymptotic agreement under Bayesian learning, Working paper, MIT.
, , , and (2006). Margin, short selling, and lotteries in experimental asset markets. Southern Economic Journal 73 419–36.CrossRefGoogle Scholar
and (2010). Liquidity and leverage. Journal of Financial Intermediation 19 418–437.CrossRefGoogle Scholar
and (1998). Nonparametric estimation of state–price densities implicit in financial asset prices. Journal of Finance 53 499–547.CrossRefGoogle Scholar
and (1982). A progress report on the training of probability assessors. In Judgement Under Uncertainty: Heuristics and Biases, , , and , (eds). Cambridge University Press, Cambridge.Google Scholar
, , and (2005). Do heterogeneous beliefs matter for asset pricing?Review of Financial Studies 18 875–924.CrossRefGoogle Scholar
, , and (2003). When does the market matter? Stock prices and the investment of equity-dependent firms. Quarterly Journal of Economics 118 969–1006.CrossRefGoogle Scholar
(2011). Learning from prices and the dispersion in beliefs. Review of Financial Studies 24 3025–3068.CrossRefGoogle Scholar
and (2000). Trading is hazardous to your wealth: The common stock investment performance of individual investors. Journal of Finance 55 773–806.CrossRefGoogle Scholar
, , , and (2009). Just how much do individual investors lose by trading?Review of Financial Studies 22 609–632.CrossRefGoogle Scholar
(2011). Psychology and the financial crisis of 2007–2008. Working paper, Yale University.Google Scholar
, , and (1998). A model of investor sentiment. Journal of Financial Economics 49 307–343.Google Scholar
and (2003). A survey of behavioral finance. In Handbook of the Economics of Finance, , , (eds). North-Holland, Amsterdam.Google Scholar
(2000). A model of dynamic equilibrium asset pricing with heterogeneous beliefs and extraneous risk. Journal of Economic Dynamics and Control 24 63–95.CrossRefGoogle Scholar
and (2004). Pay Without Performance: The Unfulfilled Promise of Executive Compensation. Harvard University Press, MA.Google Scholar
, , and (2010). Managerial Miscalibration. NBER working paper 16215.
(2009). Groupthink: Collective delusions in organizations and markets. Working paper, Princeton University.CrossRefGoogle Scholar
, , and (1993). The stock market, profit and investment. Quarterly Journal of Economics 107 115–136.Google Scholar
and (1983). Bubbles, rational expectations and financial markets. National Bureau of Economic Research, NBER Working Papers 945.
and (1992). Evolution and market behavior. Journal of Economic Theory 58 9–40.CrossRefGoogle Scholar
and (2006). If you're so smart, why aren't you rich? Belief selection in complete and incomplete markets. Econometrica 74 929–966.CrossRefGoogle Scholar
, , and (2011). Outside and inside liquidity. Quarterly Journal of Economics 126 259–321.CrossRefGoogle Scholar
, , and (2005). Pay for short-term performance: Executive compensation in speculative markets. Journal of Corporation Law 30 721–747.Google Scholar
, , and (2006). Executive compensation and short-termist behavior in speculative markets. Review of Economic Studies 73 577–610.CrossRefGoogle Scholar
, , and (2007). Efficiency and the bear: Short sales and markets around the world. Journal of Finance 62 1029–1079.CrossRefGoogle Scholar
and (2009). Funding liquidity and market liquidity. Review of Financial Studies 22 2201–2238.CrossRefGoogle Scholar
, and (2012). A welfare criterion for models with distorted beliefs. Working paper, Princeton University.Google Scholar
and (2006). Model uncertainty and option markets with heterogeneous beliefs. Journal of Finance 61 2841–97.CrossRefGoogle Scholar
, , and (1997). The Econometrics of Financial Markets. Princeton University Press, NJ.Google Scholar
(2011). Collateral shortages, asset price and investment volatility with heterogeneous beliefs. Working paper, Georgetown University.Google Scholar
, , and (2011). Rare disasters and risk sharing with heterogeneous beliefs. Working paper, MIT.CrossRef
, , and (2002). Breadth of ownership and stock returns. Journal of Financial Economics 66 171–205.CrossRefGoogle Scholar
, , and (2012). Wall Street and the housing bubble: Bad incentives, bad models, or bad luck? Working paper, Princeton University.Google Scholar
and (2011). Noise traders, distant speculators and asset bubbles in the housing market. Working paper, Columbia University.Google Scholar
and (1996). Asset pricing with heterogeneous consumers. Journal of Financial Economics 104 219–240.Google Scholar
and (2007). Asset fire sales (and purchases) in equity markets. Journal of Financial Economics 86, 479–512.CrossRefGoogle Scholar
and (2009). Asset pricing in a monetary economy with heterogeneous belief. Working paper, McGill University.Google Scholar
, , and (2010). Balance sheet capacity and endogenous risk. Working paper, London School of Economics and Princeton University.Google Scholar
, , and (1998). Investor psychology and security market under- and over-reactions. Journal of Finance 53 1839–1885.CrossRefGoogle Scholar
(2008). Heterogeneous beliefs, speculation, and the equity premium. Journal of Finance 63 41–83.CrossRefGoogle Scholar
, , and (2002). Differences of opinion and the cross section of stock returns. Journal of Finance 57 2113–2141.CrossRefGoogle Scholar
, , , and (1990). Noise trader risk in financial market. Journal of Political Economy 98 703–738.CrossRefGoogle Scholar
, , , and (1991). The survival of noise traders in financial markets. Journal of Business 64 1–19.Google Scholar
and (1994). Intertemporal asset pricing with heterogeneous beliefs. Journal of Economic Theory 62 294–320.CrossRefGoogle Scholar
(2011). Rare event risk and heterogeneous beliefs: The case of incomplete markets. Journal of Financial and Quantitative Analysis 46 459–488.CrossRefGoogle Scholar
(2010). Asset price dynamics with slow-moving capital, (American Finance Association Presidential Address). Journal of Finance 65 1237–1267.CrossRefGoogle Scholar
, , and (2002). Securities lending, shorting, and pricing. Journal of Financial Economics 66 307–339.CrossRefGoogle Scholar
, , and (2005). Bubbles and experience: An experiment on speculation. American Economic Review 95 1731–1737.CrossRefGoogle Scholar
, , and (2009). Equilibrium portfolio strategies in the presence of sentiment risk and excess volatility. Journal of Finance 64 579–629.CrossRefGoogle Scholar
, , and (2011). Differences of opinion and international equity markets. Working paper, Wharton School.CrossRefGoogle Scholar
and (2008). Leverage cycles and the anxious economy. American Economic Review 98 1211–1244.CrossRefGoogle Scholar
and (1999). The pricing of US catastrophe reinsurance. In The Financing of Catastrophe Risk, (ed). University of Chicago Press, Chicago, IL.CrossRefGoogle Scholar
and (2008). An examination of heterogeneous beliefs with a short-sale constraint in a dynamic economy. Review of Finance 12 323–364.Google Scholar
(2000). Famous First Bubbles: The Fundamentals of Early Manias. MIT Press, Cambridge, Mass.Google Scholar
and (2011). Margin-based asset pricing and deviations from the law of one price. Review of Financial Studies 24 1980–2022.CrossRefGoogle Scholar
(2003), Liquidity, default, and crashes: Endogenous contracts in general equilibrium, In Advances in Economics and Econometrics Theory and Applications, Eighth World Conference, Vol 2. Econometric Society Monographs, pp. 170–205.Google Scholar
, , and (2002). Stocks are special too: an analysis of the equity lending market. Journal of Financial Economics 66 241–269.CrossRefGoogle Scholar
, and (2001). Learning to be overconfident. Review of Financial Studies 14 1–27.CrossRefGoogle Scholar
, , and (2005). Do stock price bubbles influence corporate investment?Journal of Monetary Economics 52 805–827.CrossRefGoogle Scholar
and (2000). The investment behavior and performance of various investor types: a study of Finland's unique data set. Journal of Finance 55 43–67.Google Scholar
and (1992). The weighing of evidence and the determinants of overconfidence. Cognitive Psychology 24 411–435.CrossRefGoogle Scholar
and (2002). Equilibrium and welfare in markets with financially constrained arbitrageurs. Journal of Financial Economics 66 361–407.CrossRefGoogle Scholar
and (2010). Limits of arbitrage: The state of the theory. Annual Review of Financial Economics 2 251–275.CrossRefGoogle Scholar
and (1980). On the impossibility of informationally efficient markets. American Economic Review 70 393–408.Google Scholar
and (1993). Differences of opinion make a horse race. Review of Financial Studies 6 473–506CrossRefGoogle Scholar
, and (1978). Speculative investor behavior in a stock-market with heterogeneous expectations. Quarterly Journal of Economics 92 323–336.CrossRefGoogle Scholar
and (2006). The effect of short selling on bubbles and crashes in experimental spot asset markets. Journal of Finance 61 1119–1157.CrossRefGoogle Scholar
, , and (2007). Traders' expectations in asset markets: experimental evidence. American Economic Review 97 1901–1920.CrossRefGoogle Scholar
, , , and (2011). Real estate investors, the leverage cycle and the housing market crisis. Federal Reserve Bank of New York, Staff Reports, no. 514, September 2011. Available at www.newyorkfed.org/research/staff_reports/sr514.html.Google Scholar
and (2009). Intermediary asset pricing. Working paper, University of Chicago and Northwestern University.Google Scholar
and (2010). Delegated asset management and investment mandates. Working paper, University of Chicago and Princeton University.Google Scholar
and (2012). Debt financing in asset markets. American Economic Review Papers and Proceedings 102 88–94.CrossRefGoogle Scholar
, and (2007). Price bubbles sans dividend anchors: Evidence from laboratory stock markets. Journal of Economic Dynamics and Control 31 1875–1909.CrossRefGoogle Scholar
(2001). Investor psychology and asset pricing. Journal of Finance 56 1533–1597.CrossRefGoogle Scholar
and (2003). Analyzing the analysts: Career concerns and biased earnings forecasts. Journal of Finance 58 313–351.CrossRefGoogle Scholar
, , and (2006). Asset float and speculative bubbles. Journal of Finance 61 1073–1117.CrossRefGoogle Scholar
and (2003). Differences of opinion, short-sales constraints, and market crashes. Review of Financial Studies 16 487–525.CrossRefGoogle Scholar
and (2007). Disagreement and the stock market. Journal of Economic Perspectives 21 109–128.CrossRefGoogle Scholar
, , and (2008). Thar she blows: Can bubbles be rekindled with experienced subjects?American Economic Review 98 924–937.CrossRefGoogle Scholar
(1980). Heterogeneous expectations, restrictions on short-sales, and equilibrium asset prices. Journal of Finance 35 1105–1113.CrossRefGoogle Scholar
and (2007). Consensus consumer and intertemporal asset pricing with heterogeneous beliefs. Review of Economic Studies 74 1149–1174.CrossRefGoogle Scholar
and (1995). Differential interpretation of public signals and trade in speculative markets. Journal of Political Economy 103 831–872.CrossRefGoogle Scholar
(1978). Manias, Panics, and Crashes: A History of Financial Crises. John Wiley and Sons, New York.CrossRefGoogle Scholar
(2009). Risk in dynamic arbitrage: The price effects of convergence trading. Journal of Finance 64 631–655.CrossRefGoogle Scholar
, , , and (2006). The price impact and survival of irrational traders. Journal of Finance 61 195–229.CrossRefGoogle Scholar
(2009). Amplification mechanisms in liquidity crises. American Economic Journals – Macroeconomics 2 1–33.Google Scholar
(1994). On the structure and diversity of rational beliefs. Economic Theory 4 877–900.CrossRefGoogle Scholar
(1996). Rational beliefs and endogenous uncertainty, Economic Theory 8 383–397.CrossRefGoogle Scholar
and (1997). Speculation duopoly with agreement to disagree: Can overconfidence survive the market test?Journal of Finance 52 2073–90.CrossRefGoogle Scholar
and (2003). Can the market add and subtract? Mispricing in tech stock carve-outs. Journal of Political Economy 111 227–268.CrossRefGoogle Scholar
, , and (2001). Non-speculative bubbles in experimental asset markets: Lack of common knowledge of rationality vs. actual irrationality, Econometrica 69 830–859.CrossRefGoogle Scholar
. and (1998). Underwriting relationships, analysts' earnings forecasts and investment recommendations. Journal of Accounting and Economics 25 101–127.CrossRefGoogle Scholar
(1841). Extraordinary Popular Delusions and the Madness of CrowdsOffice of the National Illustrated Library, London.Google Scholar
and (2007). Are investors naive about incentives?Journal of Financial Economics 85 457–489.CrossRefGoogle Scholar
, , and (2004). Disagreement about inflation expectations, NBER Macroeconomics Annual 2003 18 209–248.Google Scholar
, , and (2009). Speculative trading and stock prices: Evidence from Chinese A–B share premia. Annals of Economics and Finance 10 225–255.Google Scholar
and (2009). The consequences of mortgage credit expansion: Evidence from the US mortgage default crisis. Quarterly Journal of Economics 124 1449–1496.CrossRefGoogle Scholar
and (1982). Information, trade and common knowledge. Journal of Economic Theory 26 17–27.CrossRefGoogle Scholar
(1977). Risk, uncertainty and divergence of opinion. Journal of Finance 32 1151–1168.CrossRefGoogle Scholar
(1974). The modeling of financial instability: An introduction. In Proceedings of the Fifth Annual Pittsburgh Conference, Modeling and Simulation 5 267–272.Google Scholar
, and (1990). The stock market and investment: Is the market a sideshow?Brookings Papers on Economic Activity 2 157–215.Google Scholar
(1995). The common prior assumption in economic theory, Economics and Philosophy 11 227–253.CrossRefGoogle Scholar
(1996). Speculative investor behavior and learning. Quarterly Journal of Economics 111 1111–1133.CrossRefGoogle Scholar
(1998). Volume, volatility, price, and profit when all traders are above average. Journal of Finance 53 1887–1934.CrossRefGoogle Scholar
and (2003). DotCom Mania: The rise and fall of Internet stock prices. Journal of Finance 58 1113–1137.CrossRefGoogle Scholar
(2006). The neoclassical q theory of investment in speculative markets. Working paper, University of Chicago.Google Scholar
, and (2006). Was there a NASDAQ bubble in the late 1990s?Journal of Financial Economics 81 61–100.CrossRefGoogle Scholar
, and (2009). Learning in financial markets. Annual Review of Financial Economics 1 361–381.CrossRefGoogle Scholar
and (2009). The stock market and corporate investment: A test of catering theory. Review of Financial Studies 22 187–217.CrossRefGoogle Scholar
, and (1995). Futures contracting and dividend uncertainty in experimental asset markets. Journal of Business 68 509–541.Google Scholar
and (2002). Empirical pricing kernels. Journal of Financial Economics 64 341–372.CrossRefGoogle Scholar
(1974). A two-armed bandit theory of market pricing. Journal of Economic Theory 9 185–202.CrossRefGoogle Scholar
(2000). Do markets favor agents able to make accurate predictions?Econometrica 68 1303–1342.CrossRefGoogle Scholar
, and (2003). Overconfidence and speculative bubbles. Journal of Political Economy 111 1183–1219.CrossRefGoogle Scholar
and (1983). Don't bet on it: Contingent agreements with asymmetric information. Journal of the American Statistical Association 78 424–426.CrossRefGoogle Scholar
, , and (2011). Collateral-motivated financial innovation. Working paper, Yale University.Google Scholar
(2008). Inflation expectations, uncertainty, and monetary policy. Working paper, Princeton University.Google Scholar
(2010). Belief disagreements and collateral constraints. Working paper, Harvard University.Google Scholar
(2011). Speculation and risk sharing with new financial assets. Working paper, Harvard University.CrossRefGoogle Scholar
, , and (1988). Bubbles, crashes, and endogenous expectations in experimental spot asset markets, Econometrica 56 1119–1151.CrossRefGoogle Scholar
(1996). Rational capital budgeting in an irrational world. Journal of Business 69 429–455.Google Scholar
(2000). Views of financial economists on the equity premium and on professional controversies. Journal of Business 73 501–537.Google Scholar
(1990). The stock market boom and crash of 1929 revisited. Journal of Economic Perspectives 4 67–83.CrossRefGoogle Scholar
(2001). Convergence trading with wealth effects: An amplification mechanism in financial markets. Journal of Financial Economics 62 247–292.CrossRefGoogle Scholar
and (2010). Heterogeneous expectations and bond markets. Review of Financial Studies 23 1433–1466.CrossRefGoogle Scholar
and (2011). The Chinese warrants bubble. American Economic Review 101 2723–2753.CrossRefGoogle Scholar
(2008). Natural selection in financial markets: Does it work?Management Science 54 1935–1950.CrossRefGoogle Scholar
(2011). Disagreement and return predictability of stock portfolios. Journal of Financial Economics 99 162–183.CrossRefGoogle Scholar
(1998). Effects of financial innovations on market volatility when beliefs are heterogeneous. Journal of Economic Dynamics and Control 22 597–626.CrossRefGoogle Scholar
- 41
- Cited by