Bubbles and Contagion in Financial Markets, Volume 1: An by E. Porras

By E. Porras

Asset bubbles and contagion have had a profound impression at the monetary markets after the monetary and sovereign debt crises. This booklet takes a quantitative method of studying those phenomena and should attract practitioners who have to comprehend the repercussions of those occasions on buying and selling exchanges and the markets.

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Sample text

However, no genuine analysis of financial viability was ever performed. This was a market open to any company who wished to put itself forward. Thus, around 272 bills were passed, amounting to 9,500 miles of railway. Not surprisingly, one reason for such Parliamentary largesse was the fact that many Members of Parliament were also railway investors. Over time, as numerous companies began to operate, it became obvious that many of the routes were not commercially viable: contrary to earlier suppositions, railways were not simple projects with certain growth and return patterns.

Bounded rationality To explain bubbles and contagion, there are behavioral models assuming the existence of some rational traders. These models can be grouped into four categories:63 a. Differences of opinion and short sale constraints. Within this group, optimistic investors disregard the fact that pessimistic-short-sale constrained investors imprint their views into prices. Given the differences in opinion and action regarding 20 Bubbles and Contagion in Financial Markets, Volume 1 future outcomes resulting from personality traits and sale constraints, the market price of the asset will have a bubble component.

Also, these are ever more difficult to assess as they now appear intrinsically connected to the recent and expected growth. There is a retro-feedback mechanism by which beliefs are reinforced by increased prices, and prices increase further, pushed by the money invested in the bubble as a consequence of the actions resulting from these strengthened beliefs. In this phase, it is mainly the money of the general public – unsophisticated investors – that pushes the market up, while the experienced investors start to collect their returns and de-scale their investments.

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