Psychological Aspects of Market Crashes



Figure 3 below maps crash magnitudes as a function of both the anticipa-
tion levels and endowments drops. Regions of relatively low endowment drops

0.

0.2

Figure 3: e-crash as a function of the anticipation and drop (α = 10)

and low anticipations leads to moderate crashes. Regions of high anticipa-
tions of drops trigger the highest levels of crash, and such high anticipations
significantly intensify the crash magnitudes regardless of the drop level. Pro-
vided that anticipations are high enough, severe drops in endowment lead
to severe crashes (as is commonly believed), but our point is to show that
anticipations do intensify this phenomena. That is, psychological factors as
described here turn crashes from bad to significantly worse.

17



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