Psychological Aspects of Market Crashes

last point implies that the crash occurs independently of the true probability
of a drop next period, showing that the anticipation (together with the drop
of course) has driven the crash.

The next figure gives us a way to visualize the effect of drop anticipations
on the magnitude of a crash, given a particular drop of endowment next
period. We fix a 20% drop in the following simulation.

Figure 2: Crash magnitude as a function of the anticipation δ (α = 10)

Figure 2 provides the direct link between the magnitude of the crash and
the anticipation of the drop. Its main implication is that, for a fixed drop
of endowment, the higher the anticipation the higher the crash magnitude.
The intuition of this point is also given in the Introduction.

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