Role of Leverage in Bubbles and Crashes
AbstractThis paper investigates the possibility that an unproductive company with limited debt capacity raises huge funds through share issuances by utilizing a small sign of enthusiasm. We generalize the timing game of Matsushima (2012) by permitting arbitrageurs to use high leverage for purchasing the shares. Thanks to this leverage, any arbitrageur has strong incentive to ride the bubble by continuing to purchase them, instead of timing the market quickly. We show that the harmful bubble persists for a long time as the unique Nash equilibrium. Importantly, this result holds even if the underlying positive feedback traders are not very enthusiastic.
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Bibliographic InfoPaper provided by Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo in its series CARF F-Series with number CARF-F-288.
Length: 29 pages
Date of creation: Aug 2012
Date of revision:
Other versions of this item:
- NEP-ALL-2012-09-22 (All new papers)
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- Allen, Franklin & Gorton, Gary, 1993. "Churning Bubbles," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 813-36, October.
- Dilip Abreu & Markus K. Brunnermeier, 2003.
"Bubbles and Crashes,"
Econometric Society, vol. 71(1), pages 173-204, January.
- Harrison, J Michael & Kreps, David M, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, MIT Press, vol. 92(2), pages 323-36, May.
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