Business as usual, market crashes, and wisdom after the fact

Abstract

We present a three-stage model of market crashes. 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. We present an application to industry investment.

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