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Rational Finite Bubbles

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  • Franklin Allen
  • Gary Gorton

Abstract

There has been a long-running debate about whether stock market prices are determined by fundamentals. To date no consensus has been reached. An important issue in this debate concerns the circumstances in which deviations from fundamentals are consistent with rational behavior. A continuous-time example where there are a finite number of rational traders with finite wealth is presented. it is shown that a finitely-lived security can trade above its fundamental.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3707.

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Date of creation: May 1991
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Publication status: published as Allen, Franklin and Gary Gorton. Churning Bubbles." Review of Economic Studies 60, 4 no. 205 (October 1993): 813-836.
Handle: RePEc:nbr:nberwo:3707

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  1. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, American Economic Association, vol. 71(3), pages 421-36, June.
  2. Kleidon, Allan W, 1986. "Variance Bounds Tests and Stock Price Valuation Models," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 94(5), pages 953-1001, October.
  3. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, Elsevier, vol. 14(1), pages 71-100, March.
  4. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
  5. Behzad T. Diba & Herschel I. Grossman, 1988. "Rational Inflationary Bubbles," NBER Working Papers 2004, National Bureau of Economic Research, Inc.
  6. Blanchard, Olivier Jean, 1979. "Speculative bubbles, crashes and rational expectations," Economics Letters, Elsevier, Elsevier, vol. 3(4), pages 387-389.
  7. Sanford J Grossman & Joseph E Stiglitz, 1997. "On the Impossibility of Informationally Efficient Markets," Levine's Working Paper Archive 1908, David K. Levine.
  8. Franklin Allen & Gary B. Gorton, . "Rational Finite Bubbles," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 41-88, Wharton School Rodney L. White Center for Financial Research.
  9. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, Elsevier, vol. 3(4), pages 305-360, October.
  10. Kleidon, Allan W, 1986. "Bias in Small Sample Tests of Stock Price Rationality," The Journal of Business, University of Chicago Press, vol. 59(2), pages 237-61, April.
  11. Flavin, Marjorie A, 1983. "Excess Volatility in the Financial Markets: A Reassessment of the Empirical Evidence," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(6), pages 929-56, December.
  12. Sanford J. Grossman & Robert J. Shiller, 1980. "The Determinants of the Variability of Stock Market Prices," NBER Working Papers 0564, National Bureau of Economic Research, Inc.
  13. Smith, Vernon L & Suchanek, Gerry L & Williams, Arlington W, 1988. "Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets," Econometrica, Econometric Society, Econometric Society, vol. 56(5), pages 1119-51, September.
  14. LeRoy, Stephen F & Porter, Richard D, 1981. "The Present-Value Relation: Tests Based on Implied Variance Bounds," Econometrica, Econometric Society, Econometric Society, vol. 49(3), pages 555-74, May.
  15. Flood, Robert P & Garber, Peter M, 1980. "Market Fundamentals versus Price-Level Bubbles: The First Tests," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(4), pages 745-70, August.
  16. Robert J. Shiller, 1984. "Stock Prices and Social Dynamics," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(2), pages 457-510.
  17. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, Econometric Society, vol. 50(5), pages 1163-81, September.
  18. Robert J. Shiller, 1984. "Stock Prices and Social Dynamics," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 719R, Cowles Foundation for Research in Economics, Yale University.
  19. West, Kenneth D, 1988. " Bubbles, Fads and Stock Price Volatility Tests: A Partial Evaluation," Journal of Finance, American Finance Association, American Finance Association, vol. 43(3), pages 639-56, July.
  20. Faust, Jon, 1989. "Supernovas in Monetary Theory: Does the Ultimate Sunspot Rule Out Money?," American Economic Review, American Economic Association, American Economic Association, vol. 79(4), pages 872-81, September.
  21. Garber, Peter M, 1989. "Tulipmania," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 97(3), pages 535-60, June.
  22. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 66, pages 467.
  23. Olivier J. Blanchard & Mark W. Watson, 1982. "Bubbles, Rational Expectations and Financial Markets," NBER Working Papers 0945, National Bureau of Economic Research, Inc.
  24. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, Econometric Society, vol. 53(6), pages 1499-1528, November.
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  1. links for 2010-08-24
    by Brad DeLong in Grasping Reality with the Invisible Hand on 2010-08-25 04:04:43
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Cited by:
  1. Simon van Norden & Robert Vigfusson, 1996. "Avoiding the Pitfalls: Can Regime-Switching Tests Detect Bubbles?," Meeting papers, EconWPA 9603001, EconWPA.
  2. Franklin Allen & Gary Gorton, 1991. "Rational Finite Bubbles," NBER Working Papers 3707, National Bureau of Economic Research, Inc.
  3. Simon van Norden & Huntley Schaller & ), 1995. "Fads or Bubbles?," Econometrics, EconWPA 9502004, EconWPA, revised 06 Jun 1995.
  4. Tro Kortian, 1995. "Modern Approaches to Asset Price Formation: A Survey of Recent Theoretical Literature," RBA Research Discussion Papers, Reserve Bank of Australia rdp9501, Reserve Bank of Australia.
  5. Simon van Norden, 1995. "Regime Switching as a Test for Exchange Rate Bubbles," Econometrics, EconWPA 9502001, EconWPA, revised 09 Aug 1995.

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