The rational outcome should have been a panic sale of
obligations denominated in the collapsing currency. But the devaluation
is so excessive that people reasonably expect a rebound - i.e., an
appreciation of the currency - and purchase bonds rather than dispose
of them.
Yet, even Dornbusch ignored the fact that some price twirls have
nothing to do with economic policies or realities, or with the
emergence of new information - and a lot to do with mass psychology.
How else can we account for the crash of October 1987? This goes to the
heart of the undecided debate between technical and fundamental
analysts.
As Robert Shiller has demonstrated in his tomes "Market Volatility" and
"Irrational Exuberance", the volatility of stock prices exceeds the
predictions yielded by any efficient market hypothesis, or by
discounted streams of future dividends, or earnings. Yet, this finding
is hotly disputed.
Some scholarly studies of researchers such as Stephen LeRoy and Richard
Porter offer support - other, no less weighty, scholarship by the likes
of Eugene Fama, Kenneth French, James Poterba, Allan Kleidon, and
William Schwert negate it - mainly by attacking Shiller's underlying
assumptions and simplifications.
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