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Slow boom, sudden crash

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Many asset markets exhibit a pattern of slow booms and sudden crashes. This paper presents an explanation based on an endogenous speed of learning. In the model, more observable economic activity take splace in good times than in bad times. Since more observable activity generates more public information about the state of the economy, faster learning takes place in good times. Therefore, if the state of the economy changes when times are good and learning is fast, asset prices adjust quickly and a sudden crash occurs. When times are bad and learning is slower, agents take longer to react as the economy improves ; a more gradual boom ensues. Data from US and developing-country credit markets are consistent with the theory.

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