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Speculative Bubbles and Financial Crises

  • Pengfei Wang
  • Yi Wen

Are asset prices unduly volatile and often detached from their fundamentals? Does the bursting of financial bubbles depress the real economy? This paper addresses these issues by constructing a DSGE model with speculative bubbles. We characterize conditions under which storable goods, regardless of their intrinsic values, can carry bubbles, and agents are willing to invest in such bubbles despite their positive probability of bursting. The results show that systemic risk, commonly perceived changes in the bubble's probability of bursting, can generate boom-bust cycles with hump-shaped output dynamics and produce asset price movements many times more volatile than the economy's fundamentals. (JEL E13, E23, E32, E44, G01, G12).

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/mac.4.3.184
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File URL: http://www.aeaweb.org/aej/mac/data/2010-0074_data.zip
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Article provided by American Economic Association in its journal American Economic Journal: Macroeconomics.

Volume (Year): 4 (2012)
Issue (Month): 3 (July)
Pages: 184-221

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Handle: RePEc:aea:aejmac:v:4:y:2012:i:3:p:184-221
Note: DOI: 10.1257/mac.4.3.184
Contact details of provider: Web page: https://www.aeaweb.org/aej-macro
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  1. Farhi, Emmanuel & Tirole, Jean, 2008. "Competing Liquidities: Corporate Securities Real Bonds and Bubbles," IDEI Working Papers 506, Institut d'Économie Industrielle (IDEI), Toulouse.
  2. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-20, April.
  3. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
  4. Patrick-Antoine Pintus & Yi Weng, 2009. "Leveraged financing, over investment, and boom-bust cycles," Working Papers halshs-00439245, HAL.
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