Bubbles and Market Crashes

Bernardo A. Huberman and Thad Hogg
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Thad Hogg: Dynamics of Computation Group Xerox Palo Alto Research Center Palo Alto, CA

Working Papers from Xerox Research Park

Abstract: We present a dynamical theory ofasset price bubbles that exhibits the appearance of bubbles and their subsequent crashes. We show that when speculative trends dominate over fundamental beliefs, bubbles form, leading to the growth of asset prices away from their fundamental value. This growth makes the system increasingly susceptible to any exogenous shock, thus eventually precipitating a crash.We also present computer experiments which in their aggregate behavior confirm the predictions of the theory.

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