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Slow Boom, Big Crash

Many asset markets exhibit a pattern of slow booms and sudden crashes. This paper presents an explanation for this unconditional asymmetry in asset price movements based on an endogenous speed of learning. In the model, more observable economic activity takes place in good times than in bad times. Since more observable activity generates more public information about the state of the economy, faster learning takes place in good times. Therefore, if the state of the economy changes when times are good and learning is fast, asset prices adjust quickly and a sudden crash occurs. When times are bad and learning is slower, agents take longer to discover that the economy has improved, and a more gradual boom ensues. The paper also presents data from U.S.and developing- country credit markets that are consistent with the theory.

Author(s)
Laura Veldkamp
Publication Date
December, 2000