Informational overshooting, booms, and crashes

This paper offers an informational explanation to stock markets' booms and crashes. This explanation builds on the idea of 'informational overshooting': if market fundamentals change for an unknown period of time, prices experience a boom, which ends in a crash, due to informational dynamics. The paper then shows that 'informational overshooting' occurs when the market expands to a new capacity, which is unknown until it is reached. The paper presents two examples of such expansions, one due to increased productivity and the other due to entry of new investors to the stock market. One implication is that financial liberalizations tend to be followed by booms and crashes. (C) 1999 Elsevier Science B.V. All rights reserved. JEL classification: D83; G19.