Abstract:

This paper analyzes the sensitivity of market crashes to investors’ psychology in a standard general equilibrium framework with het- erogenous beliefs. Contrary to the traditional view that market crashes are driven by large drops in aggregate endowments, we show that: 1- the magnitude of the crash is an increasing function of the lower bound of individual anticipations about endowments drop provided that an- ticipations are significant enough, and 2- no crash occurs regardless of the endowments drop when those anticipations are small.