Abstract

We investigate how stochastic asset price dynamics with herding and financial constraints in heterogeneous agents’ decisions explain the presence of a period of financial distress (PFD) following the peak and preceding the crash of a bubble, documented by Kindleberger [2000, Appendix B] as common among most major historical speculative bubbles. Simulations show the PFD is due to agents’ wealth distribution dynamics, selling because of financial constraints after the bubble’s peak in relation to switching behavior of agents. An increase in switching tendency increases the length of the PFD and decreases bubble amplitude, while increasing strength of interaction between the agents increases bubble amplitude.