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Rational Asset Price Bubbles

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  • Behzad T. Diba
  • Herschel I. Grossman

Abstract

The solution to a linear model in which supply and/or demand depends on rational expectations of future prices can involve three parts, which we denote as the fundamental component, the deterministic bubble component, and the stochastic bubble component. This paper explores the properties of these solution components, emphasizing the distinction between deterministic bubbles and stochastic bubbles, for a model of inflation and for a model of the evolution of price and quantity in the market fora storable commodity, such as gold. The analysis focuses on stochastic bubbles as a possibility peculiarly associated with models that involve rational expectations. In both the inflation model and the gold model, although the analysis points to no compelling reason to rule out rational stochastic bubbles apriori, conventional behavioral assumptions imply that anyrational bubbles that arise, whether deterministic or stochastic,are explosive. The paper discusses problems of implementing econometric tests for the existence of rational bubbles, and, as an alternative to these tests, suggests "diagnostic checking" of the stationarity properties of time series. Although these diagnostic checks do not constitute definitive hypothesis testing, we conjecture they would provide strong evidence against rational bubbles outside the context of hyperinflation.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1059.

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Date of creation: Jan 1983
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Publication status: published as Diba, Behzad T. and Herschel I. Grossman. "The Theory Of Rational Bubbles In Stock Prices," Economic Journal, 1988, v98(392), 746-754.
Handle: RePEc:nbr:nberwo:1059

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  1. Salant, Stephen W & Henderson, Dale W, 1978. "Market Anticipations of Government Policies and the Price of Gold," Journal of Political Economy, University of Chicago Press, vol. 86(4), pages 627-48, August.
  2. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  3. Taylor, John B, 1977. "Conditions for Unique Solutions in Stochastic Macroeconomic Models with Rational Expectations," Econometrica, Econometric Society, vol. 45(6), pages 1377-85, September.
  4. Maurice Obstfeld & Kenneth Rogoff, 1981. "Speculative hyperinflations in a maximizing models: can we rule them out?," International Finance Discussion Papers 195, Board of Governors of the Federal Reserve System (U.S.).
  5. Stephen W. Salant & Dale W. Henderson, 1976. "Market anticipations, government policy, and the price of gold," International Finance Discussion Papers 81, Board of Governors of the Federal Reserve System (U.S.).
  6. Dasgupta,P. S. & Heal,G. M., 1985. "Economic Theory and Exhaustible Resources," Cambridge Books, Cambridge University Press, number 9780521297615, April.
  7. Kingston, Geoffrey H., 1982. "The semi-log portfolio balance schedule is tenuous," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 389-399.
  8. Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
  9. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
  10. Flood, Robert P & Garber, Peter M, 1980. "Market Fundamentals versus Price-Level Bubbles: The First Tests," Journal of Political Economy, University of Chicago Press, vol. 88(4), pages 745-70, August.
  11. Robert J. Shiller, 1975. "Rational Expectations and the Dynamic Structure of Macroeconomic Models:A Critical Review," NBER Working Papers 0093, National Bureau of Economic Research, Inc.
  12. Burmeister, Edwin & Wall, Kent D., 1982. "Kalman filtering estimation of unobserved rational expectations with an application to the German hyperinflation," Journal of Econometrics, Elsevier, vol. 20(2), pages 255-284, November.
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Cited by:
  1. Laurence Broze & Christian Gouriéroux & Ariane Szafarz, 1986. "Bulles spéculatives et transmission d'information sur le marché d'un bien stockable," ULB Institutional Repository 2013/683, ULB -- Universite Libre de Bruxelles.
  2. Cassola, Nuno & Morana, Claudio, 2002. "Monetary policy and the stock market in the euro area," Working Paper Series 0119, European Central Bank.
  3. Carlo Devillanova & Michele Maio & Pietro Vertova, 2010. "Labour mobility and the redistributive effects of trade integration," Journal of Economics, Springer, vol. 100(2), pages 95-115, June.
  4. Herschel I. Grossman, 1984. "Counterfactuals, Forecasts, and Choice-Theoretic Modelling of Policy," NBER Working Papers 1381, National Bureau of Economic Research, Inc.
  5. Erwin W. Heri, 1986. "Irrationales rational gesehen: Eine Übersicht über die Theorie der "Bubbles"," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 122(II), pages 163-186, June.
  6. Behzad T. Diba & Herschel I. Grossman, 1984. "Rational Bubbles in the Price of Gold," NBER Working Papers 1300, National Bureau of Economic Research, Inc.
  7. repec:idb:brikps:72378 is not listed on IDEAS

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