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Beyond Mechanical Markets by Michael D. Goldberg, Roman Frydman

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10

Bounded Instability:Linking Risk and Asset-Price Swings

WE HAVE DISCUSSED how trends in fundamentals and guardedly moderate revisions of participants' forecasting strategies, and the contingency of such qualitative characterizations of change can account for the price swings observed in asset markets. We also sketched how swings in broad price indexes arise from movements in the relative prices of assets. In this chapter, we explain how these swings play an indispensable role in the process by which financial markets allocate capital to alternative projects and companies. However, we also show why, owing to imperfect knowledge, price swings can sometimes become excessive: prices move beyond a range of values that reflect what most value ...

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