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Speculative bubbles under supply constraints, background risk and investment fraud in the art market

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  • Bernales, Alejandro
  • Reus, Lorenzo
  • Valdenegro, Víctor

Abstract

We examine the unexplored effects on art markets of artist death (asset supply constraints), collectors' wealth (background risk) and forgery risk (risk of investment fraud), under short-sale constraints and risk aversion. Speculative bubbles emerge and have the form of an option strangle (a put option and a call option), in which strike prices are affected by art supply constraints and the association of the artworks' emotional value with both collectors' wealth and forgery, while the options' underlying asset is the stochastic heterogeneous beliefs of agents. We show that speculative bubbles increase with four elements: art supply constraints; a more negative correlation between collectors' wealth and the artworks' emotional value; a more positive relationship between forgery and the artworks' emotional value; and more heterogeneous beliefs. These four sources of speculation increase the expected turnover rate; however, they also augment the variance of speculative bubbles, which generates price discounts (i.e. risk premiums) for holding artworks. Consequently, the net impact of speculation is not necessarily increased art prices. This study not only contributes to the art market literature, but also to studies about speculative bubbles in other financial markets under heterogeneous beliefs, short-sale constraints and risk-averse investors, since we additionally consider the simultaneous effect of asset supply constraints, investors' background risk and the risk of investment fraud.

Suggested Citation

  • Bernales, Alejandro & Reus, Lorenzo & Valdenegro, Víctor, 2022. "Speculative bubbles under supply constraints, background risk and investment fraud in the art market," Journal of Corporate Finance, Elsevier, vol. 77(C).
    • Handle: RePEc:eee:corfin:v:77:y:2022:i:c:s0929119920301905
    DOI: 10.1016/j.jcorpfin.2020.101746
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    More about this item

    Keywords

    Art Markets; Speculative bubbles; Investment fraud; Background risk; Asset supply constraints;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law
    • Z11 - Other Special Topics - - Cultural Economics - - - Economics of the Arts and Literature

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