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Growth Cycles and Market Crashes

Staff Report 279 | Published September 1, 2000

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Growth Cycles and Market Crashes


Market booms are often followed by dramatic falls. To explain this requires an asymmetry in the underlying shocks. A straightforward model of technological progress generates asymmetries that are also the source of growth cycles. Assuming a representative consumer, we show that the stock market generally rises, punctuated by occasional dramatic falls. With high risk aversion, bad news causes dramatic increases in prices. Bad news does not correspond to a contraction of existing production possibilities, but to a slowdown in their rate of expansion. This economy provides a model of endogenous growth cycles in which recoveries and recessions are dictated by the adoption of innovations.

Published in: _Journal of Economic Theory_ (Vol. 96, Issues 1-2, January 2001, pp.13-39)