Three E ssays on Crashes , Bubbles and semi-rational B ehavior Directed by :

1. Sébastien DuchêneUniversité de Nice Sophia AntipolisGREDEG (Groupe de Recherche En Droit, Economie, Gestion) ThreeEssays on Crashes, Bubbles and semi-rational Behavior Directed by: Dominique Torre Eric Guerci

2. Three Essays on Crashes, Bubbles and semi-rational Behavior Whythistopic? With globalization, markets are essential to economy(World Capitalisation/GDP from≈34% in 1990 to ≈76% in 2012) the 2008 financial crisis was the most globalized crisis(1950/2006 : world trade*30, production*8)

3. 3 Essays on crashes, bubbles and semi-rational behavior • Questions about Financial Markets’ efficiency and traders’ rationality (Behavioral Finance: Kahneman, Tversky, Galbraith, Thaler, Shiller) • An increase in money supply, the leverage, macroeconomic imbalances, organization of markets, speculation, crowd behavior and the limits of "rationality" could continue to cause major financial crises? (Aglietta, Artus, Orlean)

4. New tops on financialmarkets

6. 3 distinct studies: • John Kenneth Galbraith, the role of emotions in speculation behavior and the 2008 financial crisis • Beyond Classical Rationality: Quantum decision theory and its criticism • Effects of short selling on bubbles and crashes

7. 1) John Kenneth Galbraith, the role of emotions in speculation behavior and the 2008 crisis A) Galbraith was a pioneer in behavioral finance that has developed over the last 30 years (cognitive biases, heuristics, limits to arbitrage, beliefs, mimicry…). Behavioral finance explains bubbles and crashes in a neutral emotional context. • without – until now – understanding the impact of emotions (euphoria, panic…) on behaviors • Galbraith was the first to add emotionin the analysis of bubbles and crashes in financial markets • Galbraith: a new field in behavioral finance with emotions B) The 2008 financial crisis is a typical extension of Galbraith’s analysis about bubbles and crashes (leverage, financial innovations, new beliefs , euphoria and panic, herding, failure of central banks…. )  Need to analyze the 2008 crisis with Galbraith’s framework

8. 1) John Kenneth Galbraith, the role of emotions in speculation behavior and the 2008 crisis • Methodology : History of EconomicThought Major works of Galbraith about financial crises: - The great Crash, 1929 (1954) - The affluent society (1958) - Money: whence it came, where it went (1975) - A tenured Professor (1990) - A short history of financial euphoria (1994) - The economics of innocent fraud (2004) - “The 1929 Parallel”, Atlantic Monthly, January, Vol. 259, 62-66, 1987.

9. 1) John Kenneth Galbraith, the role of emotions in speculation behavior and the 2008 crisis A) papers about emotions in behavioral finance Cohn, A., Engelmann, J., Fehr, E. and Maréchal, M., 2013, Evidence for Countercyclical Risk Aversion: An Experiment With Financial Professionnals, UBS Center Working Paper Series, No4 Breaban, A. andNoussair, C.N., 2013, Emotional State and Market Behavior, Working Paper Andrade, E.B., Odean, T., Lin, S., 2012, Bubbling with Excitement : An experiment, Working Paper Hargreaves Heap, S.P. and Zizzo, D.J., 2011, Emotions and chat in a financial Market experiment, Working Paper B) papers about Galbraith and the financial crises Leathers, C.G. and Raines, J.P., 2008, John Kenneth Galbraith’s Contributions to the Theory and Analysis of Speculative Financial Markets, Review of Political Economy, Vol20, No 4, 551-568 Fung, M.V., 2011, The potential contributions of behavioral finance to Post Keynesian and institutionalist finance theories, Journal of Post Keynesian Economics, Vol 33, No 4 555.

10. 2) Beyond Classical Rationality: Quantum decision theory and its criticism • Humandecisionmaking : Somelaboratoryexperimentscan not beaccountedby classicalprobabilities (Kolmogorovianprobability) and classicalexpected utility models (conjunctionfallacy, framingeffect, inverse fallacy) • cognitive biases, heuristics for example in behavioral finance • A new approachwhichcanbeseen as an extension of the mathematicalframework : the quantum decisiontheory (new concepts of rationality) • Example :Zwirn (2009) suggests to use the mathematicalformalism of the quantum theory to modelise and explain the framingeffect (Effects of interference, Superposition of states)

11. 2) Beyond Classical Rationality: Quantum decision theory and its criticism Methodology: • 1) DevelopingZwirn’smathematical model derived from quantum mechanics (new constraints….) • 2) Experimental Economics on framing effect : -Asking a question before the prisoner’s dilemma or after, and observing the results (Zwirn: interference effects) -Testing our mathematical constraints • Our first results show that there seems to be a quantum effect (Zwirn ok) but our new constraints are not met (conditional probability, vectoriel space constraint….) Literature: Franco, R., 2009, The conjunction fallacy and interference effects, Journal of Mathematical Psychology, No 53, 419-422 Lambert Mogiliansky, A., Zamir, S. and Zwirn, H., 2009 , Type Indeterminacy : A model of the KT (Kahneman-Tversky) – man, Journal of Mathematical Psychology, No 53, 349-361 Zwirn, H.P., 2009, Théorie de la décision et formalismequantique, in Bricmont , J. and Zwirn, H., Philosophie de la MécaniqueQuantique, Paris: Vuibert

12. 3) Effects of short selling on bubbles and crashes Short selling: subject of many discussions among researchers, professionals and politicians • Improve price efficiency, reduce bubbles for some researchers, not for others • Some professionals think it might increase the frequencies and the amplitudes of crashes • Some governments banned short selling during the crisis of 2008 (France, Germany, Italy, Spain…)  Academic research has mainly focused on the impact of short selling on bubbles. We want to look at its impact on crashes

13. 3) Effects of short selling on bubbles and crashes • Methodology: ExperimentalEconomics and Econometrics  Experimentalassetmarketswith a new design focused on crashes.  Showing the negative impact of short selling on crashes (volatility, frequences of crashes, and amplitudes) • Literature: Haruvy, H., and Noussair, C.N.,2006, The Effect of Short Selling on Bubbles and Crashes in Experimental Spot Asset Markets, Journal of Finance, Vol 61, No 3, 1119-1157 Smith, V.L., Suchanek, G.L. and Williams, A.W., 1988, Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets, Econometrica, Vol 56, No 5, 1119-1151 De Long, J.B., Shleifer, A., Summers, L.H., and Waldmann, R.J., 1990, Positive Feedback Investments Strategies and Destabilizing Rational Speculation, Journal of Finance, Vol 65, No 2, 379-395

14. Thanks for yourkind attention