Working Papers

The Financial System

F-series

Date:

Number:CARF-F-144

Behavioral Aspects of Arbitrageurs in Timing Games of Bubbles and Crashes

Author:Hitoshi Matsushima

Abstract

We model a timing game of bubbles and crashes a la Abreu and Brunnermeier (2003), in which arbitrageurs compete with each other to beat the gun in a stock market.However, unlike Abreu and Brunnermeier, instead of assuming sequential awareness,the present paper assumes that with a small probability, each arbitrageur is behavioral and committed to ride the bubble at all times. We show that with incomplete information, even rational arbitrageurs are willing to ride the bubble. In particular, the bubble can persist for a long period as the unique Nash equilibrium outcome.

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