A Model of Bubbles and Crashes
This paper presents a model in which an asset bubble may persist despite the presence of a large mass of rational arbitrageurs whose joint responses would suffice to burst the bubble. The resilience of the bubble stems from the inability of arbitrageurs to temporarily coordinate their selling strategies. This synchronization problem together with the individual incentive to time the market results in the persistence of bubbles over a substantial period. The analysis suggests that behavioral influences on prices are immune to arbitrage in the short and medium run. The model provides a natural setting in which news events, by enabling synchronization, may have a disproportionate impact relative to their intrinsic informational content.