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Handbook on Systemic Risk by Joseph A. Langsam, Jean-Pierre Fouque

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24

Bubbles, Crises, and Heterogeneous Beliefs

Wei Xiong

Abstract Heterogeneous beliefs are a widely observed attribute of individuals. This chapter reviews the quickly growing literature that builds on heterogeneous beliefs to explain bubbles, crises, and endogenous risk in financial markets.

The history of financial markets has been dotted with episodes of bubbles, during which market values of assets vastly exceeded reasonable assessments of their fundamental value. Asset price bubbles can lead to severe economic consequences ranging from wasteful over-investment and frenzied trading during booms to devastating financial crises and depressed real economies during busts. Economists have emphasized many aspects of bubbles and crises. Minsky (1974) ...

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