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Bubbles and Crises

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  • Allen, Franklin
  • Gale, Douglas

Abstract

In recent financial crises a bubble, in which asset prices rise, is followed by a collapse and widespread default. Bubbles are caused by agency relationships in the banking sector. Investors use money borrowed from banks to invest in risky assets, which are relatively attractive because investors can avoid losses in low payoff states by defaulting on the loan. This risk shifting leads investors to bid up the asset prices. Risk can originate in both the real and financial sectors. Financial fragility occurs when positive credit expansion is insufficient to prevent a crisis.

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Bibliographic Info

Article provided by Royal Economic Society in its journal The Economic Journal.

Volume (Year): 110 (2000)
Issue (Month): 460 (January)
Pages: 236-55

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Handle: RePEc:ecj:econjl:v:110:y:2000:i:460:p:236-55

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References

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  1. Holmstrom, Bengt & Tirole, Jean, 1997. "Financial Intermediation, Loanable Funds, and the Real Sector," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 663-91, August.
  2. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
  3. Manuel S. Santos & Michael Woodford, 1997. "Rational Asset Pricing Bubbles," Econometrica, Econometric Society, vol. 65(1), pages 19-58, January.
  4. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  5. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-76, June.
  6. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  7. Weil, Philippe, 1987. "Confidence and the Real Value of Money in an Overlapping Generations Economy," The Quarterly Journal of Economics, MIT Press, vol. 102(1), pages 1-22, February.
  8. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
  9. De Long, J Bradford, et al, 1990. " Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance, American Finance Association, vol. 45(2), pages 379-95, June.
  10. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  11. Higgins, Matthew & Osler, Carol, 1997. "Asset Market Hangovers and Economic Growth: The OECD during 1984-93," Oxford Review of Economic Policy, Oxford University Press, vol. 13(3), pages 110-34, Autumn.
  12. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  13. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
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