rational panics and stock market crashes abstract this paper offers an explanation for stock market crashes which focuses on the role of rational but uninformed traders we show that uninformed traders can precipitate a price crash because as prices decline they surmise that informed traders received negative information which leads them to reduce their demand for assets and drive the price of stocks even lower the model yields several implications such as that crashes can occur even when the fundamentals are strong and that the magnitude of the crash depends on the fraction of uninformed investors and the amount of unsophisticated passive investing present in the market

self fulfilling currency crises the role of interest rates abstract we develop a stylized currency crises model with heterogeneous information among investors andendogenous determination of interest rates in a noisy rational expectations equilibrium our modelcaptures three key features of interest rates the opportunity cost of attacking the currency respondsto the investors behavior the domestic interest rate may influence the central bank s preferences fora fixed exchange rate and the domestic interest rate serves as a public signal which aggregatesprivate information about fundamentals we explore the payoff and informational channels throughwhich interest rates determine devaluation outcomes and examine the implications for equilibriumselection by global games methods our main conclusion is that multiplicity is not an artifact ofcommon knowledge in particular we show that multiplicity emerges robustly either when adevaluation is triggered by the cost of high domestic interest rates as in obstfeld 1996 or when adevaluation is triggered by the central bank s loss of foreign reserves as in obstfeld 1986 providedthat the domestic asset supply is sufficiently elastic in the interest rate and shocks to the domesticbond supply are sufficiently small christian helliwigdepartment of economicsuniversity of california los angelesbox 951477los angeles ca 90095 1477arijit mukherjiuniversity of minnesotaaleh tsyvinskidepartment of economicsharvard universitylittauer centercambridge ma 02138 3001

the pricing effects of ambiguous private information when private information is observed by ambiguity averse investors asset prices may be informationally inefficient in rational expectations equilibrium this inefficiency implies lower asset prices as uninformed investors require a premium to hold assets and higher return volatility relative to informationally efficient benchmarks moreover asset returns are negatively skewed and may be leptokurtic inefficiency also leads to amplification in price of small changes in news relative to informationally efficient benchmarks public information affects the nature of unrevealed private information and the informational inefficiency of prices asset prices may be lower higher with good bad public information

rational asset price movements without news this paper argues that an important part of movements in asset prices may be caused by neither external news nor irrationality but by the revelation of information by the trading process itself two models are developed that illustrate this general idea one model is based on investor uncertainty about the quality of other investors information the other is based on dispersion of information and small costs to trading the analysis is used to suggest a possible rational explanation of the october 1987 crash copyright 1993 by american economic association

asymmetric price movements and borrowing constraints a rational expectations equilibrium model of crises contagion and confusion this study proposes a rational expectations equilibrium model of crises and contagion in an economy with information asymmetry and borrowing constraints consistent with empirical observations the model finds 1 crises can be caused by small shocks to fundamentals 2 market return distributions are asymmetric and 3 correlations among asset returns tend to increase during crashes the model also predicts 1 crises and contagion are likely to occur after small shocks in the intermediate price region 2 the skewness of asset price distributions increases with information asymmetry and borrowing constraints and 3 crises can spread through investor borrowing constraints

illiquidity contagion and liquidity crashes liquidity providers often learn information about an asset from prices of other assets we show that this generates a self reinforcing positive relationship between price informativeness and liquidity this relationship causes liquidity spillovers and is a source of fragility a small drop in the liquidity of one asset can through a feedback loop result in a very large drop in market liquidity and price informativeness a liquidity crash this feedback loop provides a new explanation for comovements in liquidity and liquidity dry ups it also generates multiple equilibria

on existence and uniqueness of equilibrium in a class of noisy rational expectations models i study a general class of noisy rational expectations models that nests the standard grossman and stiglitz 1980 and hellwig 1980 models but relaxes the usual assumption of joint normality of asset pay offs and supply and allows for more general signal structures i provide a constructive proof of existence of equilibrium characterize the price function and provide sufficient conditions for uniqueness within the class of equilibria with continuous price functions which are met by both the grossman and stiglitz 1980 models and the hellwig 1980 models with a continuum of investors my solution approach does not rely on the typical conjecture and verify method and i exhibit a number of non normal examples in which asset prices can be characterized explicitly and in a closed form the results presented here open up a broad class of models for applied work to illustrate the usefulness of generalizing the standard model i show that in settings with non normally distributed pay offs shocks to fundamentals may be amplified purely due to learning effects price drifts can arise naturally and the disagreement return relation depends in a novel way on return skewness

exploiting the chaos terrorist target choice following natural disasters this article explores the differences between transnational and domestic terrorism further differentiating by private versus government targets to estimate the effect of exogenous catastrophic shocks on a country s level of domestic and transnational terrorism the empirical analysis uses detailed data on terrorism natural disasters and other relevant controls for 176 countries from 1970 2007 to illuminate several key disparities in a postdisaster target choice of terrorists the results indicate that natural disasters incite both transnational and domestic terrorism however evidence is found for dissimilar motivations between the two while both types of terrorism increase after disasters transnational attacks against the government increase immediately following the disaster suggesting an impetus to exploit weakened hard targets during the chaos conversely domestic terrorism against the government takes longer to manifest suggesting a period of time for which the public recovers and assesses the government s response

the efficient market hypothesis and insider trading on the stock market we study the behavior of a large trader with private information about the mean of an asset with a risky return we argue that if the variability of the return is not too great typically the trader will find it desirable to ensure that the market price does not reveal his information that is that a pooling equilibrium arises such an equilibrium has the advantage of avoiding the incentive constraints that arise in separating equilibria where information can be inferred from prices thus the efficient market hypothesis may well fail if there is imperfect competition despite the uniformativeness of prices the other competitive traders are also better off in the pooling equilibrium than in any separating equilibrium again if one assumes limited variability

multiplicity in general financial equilibrium with portfolio constraints abstract this paper explores the role of portfolio constraints in generating multiplicity of equilibrium we present a simple financial market economy with two goods and two households households who face constraints on their ability to take unbounded positions in risky stocks absent such constraints equilibrium allocation is unique and is pareto efficient with one portfolio constraint in place the efficient equilibrium is still possible however additional inefficient equilibria in which the constraint is binding may emerge we show further that with portfolio constraints cum incomplete markets there may be a continuum of equilibria adding incomplete markets may lead to real indeterminacy

market crashes and informational avalanches this paper analyses a security market with transaction costs and a sequential trading structure transaction costs may prevent many traders from revealing their private information if they trade in a sequential fashion due to the information aggregation failure hidden information gets accumulated in the market which may be revealed by a small trigger yielding a high volatility in the absence of an accompanying event the paper first characterizes the optimal trading strategy of the agent which constitute the unique equilibrium further properties of the price sequence are obtained using the concepts of informational cascade and informational avalanche the results are applied to the explanation of market crashes in particular the dynamics of market crashes are illustrated as evolving through the following four phases 1 boom 2 euphoria 3 trigger and 4 panic where the euphoria corresponds to the informational cascade and the panic corresponds to the informational avalanche

cancellable insider trading plans an analysis of sec rule 10b5 1 rule 10b5 1 enables insiders to preplan future trades before becoming informed within a strategic rational expectations equilibrium framework i characterize an insider s unique optimal trading plan which balances portfolio diversification against exploitation of the rule s selective termination option because the rule reduces adverse selection and provides insurance against bad outcomes the rule generally improves welfare for both the insider who later becomes informed and uninformed outsiders provided there exists a sufficient degree of information asymmetry eliminating the rule s selective termination option results in an even greater welfare improvement under a large subset of parametric conditions received march 9 2018 editorial decision january 11 2019 by editor wei jiang

adaptive expectations and stock market crashes a theory is developed that explains how stocks can crash without fundamental news and why crashes are more common than frenzies a crash occurs via the interaction of rational and naive investors naive traders believe that prices follow a random walk with serially correlated volatility their expectations of future volatility are formed adaptively when the market crashes naive traders sell stock in response to the apparent increase in volatility since rational traders are risk averse as well a lower price is needed to clear the market the crash is a self fulfilling prophecy frenzies cannot occur in this model

trading frenzies and their impact on real investment we study a model in which a capital provider learns from the price of a firm s security in deciding how much capital to provide for new investment this feedback effect from the financial market to the investment decision gives rise to trading frenzies in which speculators all wish to trade like others generating large pressure on prices coordination among speculators is sometimes desirable for price informativeness and investment efficiency but speculators incentives push in the opposite direction so that they coordinate exactly when it is undesirable we analyze the effect of various market parameters on the likelihood of trading frenzies to arise

market created risk we develop a multiperiod rational expectations model of securities market equilibrium in which equilibrium prices may move between periods even though it is common knowledge that no new information has arrived about ultimate security payoffs this happens because investors know they have imperfect information about the endowments of other investors and this knowledge affects their probability beliefs about the prices that will prevail at the intermediate trading date these beliefs are reflected in the equilibrium at the initial trading date when investors focus on the probabilities of intermediate capital gains and losses rather than ultimate payoffs virtually all models of the pricing of securities employ some notion of market equilibrium so for prices to fluctuate something in the equilibrium must change since equilibrium in an informationally efficient market implies that market clearing prices reflect all available information about future securities payoffs it seems to be frequently assumed that observed jumps in prices ought under the efficient market hypothesis to reflect the arrival of new information about future cash payoffs to securities the major theme of this paper is to examine a multiperiod model of securities market equilibrium in which equilibrium prices may change sharply between periods even if it is common knowledge that no new information about ultimate payoffs has arrived and all investors are rational and make full use of all available information in our model the new information that leads to a price change is information about how much of the known total supply of risky securities is held by investors of different preferences for this model to produce intertemporal price fluctuation in equilibrium two phenomena must occur firstly the initially unknown composition of the market must not be revealed by equilibrium prices at the initial trading date secondly despite this the true composition of the market must at least partially determine prices at a later trading date they key to both these phenomena lies in the difference in investor behavior when they anticipate revising their current portfolio holdings in response to future price changes as compared to when they choose portfolios on the basis of receiving the ultimate cash payoffs to the securities they buy in practice few investors anticipating holding financial securities to their eventual liquidation by the issuer short term debt or debt close to maturity would be the major exception few equity securities relative to the total supply

short sales and stock price crash risk evidence from an emerging market abstract using a regulatory change in china as an exogenous shock we find that the removal of short sales constraints increases stock price crash risk this relation is attenuated when firms suffer less from information asymmetry highlighting the effect of interaction between uninformed and informed investors

short term investment and equilibrium multiplicity abstract i study the effects of the heterogeneity of traders horizons in a 2 period nree model where all traders are risk averse owing to risk premia short termism generates multiple equilibria in particular two distinct patterns arise along the low trading intensity equilibrium short termists anticipate a thinner second period market and owing to risk aversion scale back their trades this reduces both risk sharing and information impounding into prices enforcing a high returns volatility low price informativeness equilibrium along the high trading intensity equilibrium the opposite happens and a low volatility high price informativeness equilibrium arises thus in the presence of short term behavior and traders risk aversion periods of high volatility are a signal of poor price informativeness

information acquisition in financial markets tions agents have exponential utility and random variables are normally distributed these assumptions are often necessary to obtain closed form solutions we present an example with alternative assumptions and demonstrate that some of the conclusions from previous literature fail to hold in particular we show that in our example as more agents acquire information prices do not necessarily become more informative and agents may have greater incentive to acquire informatioln learning can therefore be a strategic complement allowing for the possibility of multiple equilibria

rational frenzies and crashes most markets clear through a sequence of sales rather than through a walrasian auctioneer because buyers can decide whether to buy now or later rather than only now or never their current willingness to pay is much more sensitive to price than the demand curve is a consequence is that markets will be extremely sensitive to new information leading to both frenzies in which demand feeds on itself and crashes in which price drops discontinuously the paper also shows how a result from static auction theory the revenue equivalence theorem can be applied to solve for a dynamic price path

business as usual market crashes and wisdom after the fact the authors present a three stage model of market dynamics in the first stage routine behavior tends to keep information of common interest trapped in private hands in the second stage private information reaches a threshold that triggers some agents to alter their behavior these actions release information to the market the final stage involves the market s response to this news as other participants react to the initial departure from routine behavior the authors present an application to industry investment they also outline applications to the international debt crisis to bank runs and to political upheavals copyright 1994 by american economic association

taking stock a comparative analysis of payments for environmental services programs in developed and developing countries abstract payments for environmental services pes are an innovative approach to conservation that has been applied increasingly often in both developed and developing countries to date however few efforts have been made to systematically compare pes experiences drawing on the wealth of case studies in this special issue we synthesize the information presented according to case characteristics with respect to design costs environmental effectiveness and other outcomes pes programs often differ substantially one from the other some of the differences reflect adaptation of the basic concept to very different ecological socioeconomic or institutional conditions others reflect poor design due either to mistakes or to the need to accommodate political pressures we find significant differences between user financed pes programs in which funding comes from the users of the es being provided and government financed programs in which funding comes from a third party the user financed programs in our sample were better targeted more closely tailored to local conditions and needs had better monitoring and a greater willingness to enforce conditionality and had far fewer confounding side objectives than government financed programs we finish by outlining some perspectives on how both user and government financed pes programs could be made more effective and cost efficient

financial entanglement a theory of incomplete integration leverage crashes and contagion abstract we propose a unified model of limited market integration asset price determination leveraging and contagion investors and firms are located on a circle and access to markets involves participation costs that increase with distance due to a complementarity between participation and leverage decisions the equilibrium may exhibit diverse leverage and participation choices across investors although investors are ex ante identical small changes in market access costs can cause a change in the type of equilibrium leading to discontinuous price changes deleveraging and portfolio flow reversals moreover the market is subject to contagion an adverse shock to investors in some locations affects prices everywhere jel d83 g11 g12 g32 g35

feedback effects and asset prices feedback effects from asset prices to firm cash flows have been empirically documented this finding raises a question for asset pricing how are asset prices determined if price affects fundamental value which in turn affects price in this environment by buying assets that others are buying investors ensure high future cash flows for the firm and subsequent high returns for themselves hence investors have an incentive to coordinate which may generate self fulfilling beliefs and multiple equilibria using insights from global games we pin down investors beliefs analyze equilibrium prices and show that strong feedback leads to higher excess volatility

stock market crashes and dynamics of aftershocks abstract we begin with the intuitive observation that short term business as usual process and bubble rising looks like an accelerated energy before an earthquake in such a framework the aftershocks resemble the correction process of the stock market we investigate the statistical properties of stock returns in the financial markets just after a major market crash it is found that the aftershocks obey the well known gutenberg richter simple rule in geophysics our empirical observations show that the statistical properties of aftershocks sequences in the crashes of late 90s and early 00s are essentially different from the ones observed a decade earlier

market liquidity hedging and crashes in the absence of significant news hedging strategies were blamed for the stock market crash of october 1987 but traditional models cannot explain how a relatively small amount of selling could cause so large a price drop the authors develop a rational expectations model in which prices play an important role in shaping expectations markets are much less liquid in their model than in traditional models discontinuities or crashes can occur even with relatively little hedging the model is consistent with theories as disparate as keynes beauty contest insights and thom s catastrophe analysis and suggests means to reduce volatility copyright 1990 by american economic association

crises and prices information aggregation multiplicity and volatility crises are volatile times when endogenous sources of information are closely monitored we study the role of information in crises by introducing a financial market in a coordination game with imperfect information the asset price aggregates dispersed private information acting as a public noisy signal in contrast to the case with exogenous information our main result is that uniqueness may not obtain as a perturbation from perfect information multiplicity is ensured with small noise in addition we show that a multiplicity may emerge in the financial price itself b less noise may contribute toward nonfundamental volatility even when the equilibrium is unique and c similar results obtain for a model where individuals observe one another s actions highlighting the importance of endogenous information more generally