Bubbles and crashes: Gradient dynamics in financial markets

Daniel Friedman and Ralph Abraham

Journal of Economic Dynamics and Control, 2009, vol. 33, issue 4, 922-937

Abstract: Fund managers respond to the payoff gradient by continuously adjusting leverage in our analytic and simulation models. The base model has a stable equilibrium with classic properties. However, bubbles and crashes occur in extended models incorporating an endogenous market risk premium based on investors' historical losses and constant-gain learning. When losses have been small for a long time, asset prices inflate as fund managers increase leverage. Then slight losses can trigger a crash, as a widening risk premium accelerates deleveraging and asset price declines.

Keywords: Bubbles; Escape; dynamics; Time; varying; risk; premium; Constant-gain; learning; Agent-based; models (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (18)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:33:y:2009:i:4:p:922-937

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