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Conditions for bubbles to arise under heterogeneous beliefs

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  • Seunghyun Lee
  • Hyungbin Park

Abstract

This study examines the price bubble of a continuous-time asset traded in a market with heterogeneous investors. Our market constitutes a positive mean-reverting asset and two groups of investors with different beliefs about the model parameters. We provide an equivalent condition for the formation of bubbles and show that price bubbles may not form, although there are heterogeneous beliefs. This suggests that investor heterogeneity does not always result in a bubble, and additional analysis on the drift term is required. Additionally, when investors agree on the volatility, the explicit bubble size can be calculated through a differential equation argument. Analysis of this bubble formula clearly justifies that our model is indeed realistic.

Suggested Citation

  • Seunghyun Lee & Hyungbin Park, 2022. "Conditions for bubbles to arise under heterogeneous beliefs," Quantitative Finance, Taylor & Francis Journals, vol. 22(3), pages 409-421, March.
    • Handle: RePEc:taf:quantf:v:22:y:2022:i:3:p:409-421
    DOI: 10.1080/14697688.2021.1990376
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