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Related Experiment Video

Updated: Dec 11, 2025

Errors as a Means of Reducing Impulsive Food Choice
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Loss aversion and market crashes.

Samuel Ouzan1

  • 1Department of Finance, NEOMA Business School, 59 Rue Pierre Taittinger, 51100, Reims, France.

Economic Modelling
|August 25, 2020
PubMed
Summary

This study models stock market crashes using rational expectations, information asymmetry, and loss aversion. It reveals how small shocks can trigger abrupt price movements and contagion, explaining puzzling crash dynamics.

Area of Science:

  • Behavioral Finance
  • Market Microstructure
  • Financial Economics

Background:

  • Stock market crashes exhibit puzzling features like abrupt, asymmetric price movements.
  • These crashes often occur without major news events and show contagion effects between unrelated assets.
  • Existing models struggle to fully explain these observed crash dynamics.

Purpose of the Study:

  • To develop a rational expectation equilibrium model of stock market crashes.
  • To incorporate information asymmetry and loss-averse speculators into the model.
  • To explain abrupt price movements, asymmetric collapses, and contagion observed in real-world market crashes.

Main Methods:

  • Developed a rational expectation equilibrium model.
  • Derived a state-dependent linear optimal trading strategy.
Keywords:
ContagionInformation asymmetryLoss aversionMarket crashesShort-sale constraints

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  • Analyzed the impact of information asymmetry, loss aversion, and short-sale constraints.

    • Main Results:

    • The model predicts nonlinear market depth and abrupt price movements from small fundamental shocks.
    • Short-sale constraints amplify asset price collapses compared to upward movements.
    • The model generates contagion effects between uncorrelated assets.

    Conclusions:

    • The model successfully replicates key puzzling features of stock market crashes.
    • Information asymmetry and loss aversion are crucial drivers of crash dynamics.
    • The findings offer insights into market fragility and the spread of financial turmoil.