DP593 Rational Frenzies and Crashes

Author(s): Jeremy I. Bulow, Paul Klemperer
Publication Date: October 1991
Keyword(s): Auctions, Crashes, Frenzies, Market Clearing
JEL(s): D44, G10, G14
Programme Areas: Applied Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=593

Most markets clear through a sequence of sales rather than through a Walrasian auctioneer. Because buyers can decide whether to buy now or later, rather than only now or never, their current `willingness to pay' is much more sensitive to price than is the demand curve. In consequence, markets will be extremely sensitive to new information, leading to frenzies where demand feeds upon itself, and crashes where price drops discontinuously. Although no buyer's independent reservation value reveals much about overall demand, a small increase in one such value can cause a large increase or decrease in average price.