Psychological Aspects of Market Crashes

From now on, we fix β = 0.9 since this parameter does not a critical role
in our analysis. Our first simulation provides a parameters region sustaining
a .85-crash, which corresponds to a drop of 15% in price of all assets traded
(assuming no dividend is paid).

Figure 1: Parameters region sustaining a .85-crash (15% price drop)

Figure 1 simultaneously displays such regions for various level of risk-
aversion. For every curve, any point of parameters above the curve sustains
the .85-crash. For instance, for an agent with a level of risk-aversion of 5, any
20% drop in endowment next period that is anticipated with probability of at
least .5 in the current period will trigger a .85-crash next if the drop actually
occurs. Figure 1 also shows that, for those last values, any anticipation level
below .5 may not trigger the crash, as is explained in the Introduction. This

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