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  • 2018
  • Working Paper

Diagnostic Bubbles

By: Pedro Bordalo, Nicola Gennaioli, Spencer Yongwook Kwon and Andrei Shleifer
  • Format:Print
  • | Language:English
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Abstract

We introduce diagnostic expectations into a standard setting of price formation in which investors learn about the fundamental value of an asset and trade it. We study the interaction of diagnostic expectations with two well-known mechanisms: learning from prices and speculation (buying for resale). With diagnostic (but not with rational) expectations, these mechanisms lead to price paths exhibiting three phases: initial underreaction, followed by overshooting (the bubble), and finally a crash. With learning from prices, the model generates price extrapolation as a byproduct of fast moving beliefs about fundamentals, which lasts only as the bubble builds up. When investors speculate, even mild diagnostic distortions generate substantial bubbles.

Keywords

Bubbles; Price Bubble; Mathematical Methods

Citation

Bordalo, Pedro, Nicola Gennaioli, Spencer Yongwook Kwon, and Andrei Shleifer. "Diagnostic Bubbles." NBER Working Paper Series, No. 25399, December 2018.
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About The Author

Andrei Shleifer

Negotiation, Organizations & Markets
→More Publications

Related Work

    • September 2021
    • Journal of Financial Economics

    Diagnostic Bubbles

    By: Pedro Bordalo, Nicola Gennaioli, Spencer Yongwook Kwon and Andrei Shleifer
Related Work
  • Diagnostic Bubbles By: Pedro Bordalo, Nicola Gennaioli, Spencer Yongwook Kwon and Andrei Shleifer
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