Wednesday, 30 December 2009

Stock market crash is triggered by drastic change in sentiment of market players

A stock market boom can be described as a bubble if there is high probability of a large scale fall in share prices.

Stock market crash is not triggered
  • by fundamental news or
  • by a certain level of share overvaluation.

Instead, it happens because of
  • a drastic change in the behavior of market players.

This is why the necessary and sufficient conditions for the bursting of a given asset price bubble, applicable in practice, cannot be provided with the tools of mathematical economics.

A market crash will ensue with a high likelihood if noise trading becomes dominant, the signals of which are to be found in the following stochastic factors:

• Increasing effect of leverage.

• Increasing activity on part of the economic policy.

• Increasing number of corporate scandals, fraud and corruption.

• Fundamentally unjustifiable co-movement of share prices.

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