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Trading and rational security pricing bubbles

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  • Jean-Marc Bottazzi

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  • Jaime Luque

    ()

  • Mario R. Pascoa

    ()

Abstract

Securities markets theory includes repo and distinguishes shorting from issuing. Here we revisit whether trading alone can give rise to Ponzi schemes and rational bubbles. We show that under the same institutional arrangements that limit re-hypothecation (e.g., through segregated haircut rules or explicit leverage constraints on haircut collecting dealers), (1) trading Ponzi schemes are prevented without having to assume uniform impatience, (2) for securities in positive net supply, bubbles are ruled out under complete markets but may occur when markets are incomplete. We give an example of such a bubble, under a finite present value of wealth.

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Bibliographic Info

Paper provided by Universidad Carlos III, Departamento de Economía in its series Economics Working Papers with number we1119.

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Date of creation: May 2011
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Handle: RePEc:cte:werepe:we1119

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Keywords: Repo; Short sale; Bubble; Repo specialness; Ponzi scheme; Leverage;

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  1. Mário R. Páscoa & Myrian Petrassi & Juan Pablo Torres-Martínez, 2009. "Fiat Money and the Value of Binding Portfolio Constraints," Working Papers Series 176, Central Bank of Brazil, Research Department.
  2. Mário Páscoa & Aloisio Araujo & José Fajardo, 2004. "Endogenous Collateral," Econometric Society 2004 Latin American Meetings 161, Econometric Society.
  3. Hart, Oliver D., 1975. "On the optimality of equilibrium when the market structure is incomplete," Journal of Economic Theory, Elsevier, vol. 11(3), pages 418-443, December.
  4. Jean Marc Bottazzi & Jaime Luque & Mario Pascoa, 2011. "Securities market theory: possession, repo and rehypothecation," 2011 Meeting Papers 1214, Society for Economic Dynamics.
  5. Markus K. Brunnermeier & Lasse Heje Pedersen, 2007. "Market Liquidity and Funding Liquidity," NBER Working Papers 12939, National Bureau of Economic Research, Inc.
  6. Páscoa, Mário Rui & Seghir, Abdelkrim, 2009. "Harsh default penalties lead to Ponzi schemes," Games and Economic Behavior, Elsevier, vol. 65(1), pages 270-286, January.
  7. Araujo, Aloisio & Novinski, Rodrigo & Páscoa, Mário R., 2011. "General equilibrium, wariness and efficient bubbles," Journal of Economic Theory, Elsevier, vol. 146(3), pages 785-811, May.
  8. Magill, Michael & Shafer, Wayne, 1991. "Incomplete markets," Handbook of Mathematical Economics, in: W. Hildenbrand & H. Sonnenschein (ed.), Handbook of Mathematical Economics, edition 1, volume 4, chapter 30, pages 1523-1614 Elsevier.
  9. Magill, Michael & Quinzii, Martine, 1996. "Incomplete markets over an infinite horizon: Long-lived securities and speculative bubbles," Journal of Mathematical Economics, Elsevier, vol. 26(1), pages 133-170.
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