Price Discovery in the Small and in the Large: Momentum and Reversal, Bubbles and Crashes
50 Pages Posted: 17 Sep 2010 Last revised: 17 Jul 2019
Date Written: April 22, 2019
Abstract
A discrete-time dynamic asset-pricing model specifies the economic rationale for a rich array of price dynamics. Two boundedly-rational investors with different risk preferences trade periodically, where excess supply is cleared by a tâtonnement. Cast at the core of asset-pricing modelling, this structure allows us to explore price discovery intra-periodically, and over time. If dividends are observable the price converges to Merton’s ICAPM, but if investors rely on past realizations, momentum and reversal patterns emerge, which might escalate to bubbles and crashes. The model features increasing volume but declining liquidity during positive bubbles, and lowest liquidity after negative bubbles.
Keywords: Price Discovery; Bubble; Crash; Momentum; Reversal
JEL Classification: C62, D53, D84, G01, G11
Suggested Citation: Suggested Citation
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