Cursed Beliefs and Asset Price Bubbles in Sequential Trading Markets: A Theoretical Framework of Belief Formation and Market Dynamics

Abstract

Forming asset price bubbles is a recurring phenomenon in financial economics and has been a persistent challenge to market prices, given the information available to marketers and rational valuation methods. Although previous research largely addresses the formation of bubbles as a question of speculation, information asymmetries and behavioral biases, the issue of the impact of belief structures as the drivers of the market dynamics has been under-researched. The research model presented in this paper is the well-known bubble model. The study aims to describe the mechanism of bubbles in a sequential trading market by introducing the concept of cursed beliefs. This paper is a conceptual study which combines the behavioral finance and sequential trading views to analyze the impact of cursed beliefs on investors' perception and the formation of their expectations and subsequent trading behavior. The theoretical analysis proposes that cursed beliefs lead to a misinterpretation of uncertainty, and thus to biased expectations and non-fundamental trading decisions. These individual belief distortions can diffuse between market participants and create collective expectations, as well as contribute to price deviations. This study has a contribution to the literature of behavioral finance in that it emphasizes the role of belief formation and social transmission as mechanisms other than information-based mechanisms in the emergence of asset price bubbles.