Slow Boom, Sudden Crash
Journal of Economic Theory October 2005, v.124(2), p.230-257.


Many asset markets exhibit a pattern of slow booms and sudden crashes. This paper presents an explanation based on an endogenous flow of information. In the model, more observable economic activity takes place in good times than in bad times. Since more activity generates more public information about the state of the economy, beliefs are more precise in good times. If the economic state changes when times are good and information is abundant, asset prices adjust quickly and a sudden crash occurs. When times are bad, information is scarce, and uncertainty is high, agents react more slowly as the economy improves; a gradual boom ensues. Data from U.S. and emerging credit markets support the theory.