Market Dynamics When Agents Anticipate Correlation Breakdown

The aim of this paper is to analyse the effect introduced in the dynamics of a financial marketwhen agents anticipate the occurrence of a correlation breakdown. What emerges is that correlationbreakdowns can act both as a consequence and as a triggering factor in the emergence of financialcrises rational bubbles. We propose a market with two kinds of agents: speculators and rationalinvestors. Rational agents use excess demand information to estimate the variance-covariancestructure of assets returns, and their investment decisions are represented as a Markowitz optimalportfolio allocation. Speculators are uninformed agents and form their expectations by imitativebehavior, depending on market excess demand. Several market equilibria result, depending on theprevalence of one of the two types of agents. Differing from previous results in the literature onthe interaction between market dynamics and speculative behavior, rational agents can generatefinancial crises, even without the speculator contribution