Credit market bubbles
Why do bubbles emerge in financial markets?
We are investigating why financial markets fail to kill off bubbles before they start, as would be expected in an (informationally) efficient market. We focus on the collateralized debt obligation (CDO) market in a clean experimental paradigm with an analogous structure. We find that individual rationality ("greed") is insufficiently powerful to overcome social rationality (the average participant is better off with than without the bubble), so bubbles emerge, but eventually will crash.