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Why Stock Markets CrashCritical Events in Complex Financial Systems$
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Didier Sornette

Print publication date: 2017

Print ISBN-13: 9780691175959

Published to Princeton Scholarship Online: May 2018

DOI: 10.23943/princeton/9780691175959.001.0001

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Positive Feedbacks

Positive Feedbacks

(p.81) Chapter 4 Positive Feedbacks
Why Stock Markets Crash

Didier Sornette

Princeton University Press

This chapter examines the main mechanisms leading to positive feedbacks, that is, self-reinforcement, such as imitative behavior and herding between investors. It shows that positive feedbacks contribute to the development of speculative bubbles, preparing the instability for a major crash. After providing an overview of feedbacks and self-organization in economics, the chapter explains how positive feedback on prices can arise due to hedging of derivatives and investment strategies with an “insurance portfolio.” It then describes a general mechanism for positive feedback, known as the “herd” or “crowd” effect, based on imitation processes. It also presents empirical evidence of herding by financial analysts and the relationship between “anti-imitation” and self-organization before concluding with an analysis of cooperative behaviors resulting from imitation, focusing on the Ising model of cooperative behavior and the complex evolutionary adaptive systems of boundedly rational agents.

Keywords:   positive feedback, herding, self-organization, derivatives, insurance portfolio, hedging, imitation, anti-imitation, cooperative behavior, rational agent

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