Psychological Aspects of Market Crashes

Psychological Aspects of Market Crashes

Patrick Leoni

National University of Ireland at Maynooth
Department of Economics

Maynooth, Co. Kildare, Ireland
e-mail: [email protected]
phone: +353 1708 6420, fax: +353 1708 3934

Abstract

This paper analyzes the sensitivity of market crashes to investors’
psychology in a standard general equilibrium framework. Contrary to
the traditional view that market crashes are driven by large drops in
aggregate endowments, we argue from a theoretical standpoint that
individual anticipations of such drops are a necessary condition for
crashes to occur, and that the magnitude of such crashes are positively
correlated with the level of individual anticipations of drops.

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