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A finite model of riding bubbles

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  • Doblas-Madrid, Antonio

Abstract

When asset prices boom over extended periods of time, many investors begin to worry about bubbles. However, even those who believe that assets are overpriced may stay in the market believing that they can rise even further before correcting. Abreu and Brunnermeier (2003, AB) model this idea in an environment with rational and behavioral agents, and more recently, Doblas-Madrid (2012, DM) constructs a fully rational version of the AB model. These models conceptualize a bubble as a boom that is at first justified by fundamentals, but overshoots as asymmetrically informed agents ride the bubble hoping to sell to a greater fool. A critique of these papers is that, although bubbles are finite, they can only arise in equilibrium if prices can grow at extraordinary rates indefinitely. In this paper, I articulate this critique in a simplified DM environment and show how it can be overturned by modifying investors’ strategies. If the number of periods an investor plans to ride the bubble is conditional on her signal of fundamental value, one can sustain speculative bubbles in a finite model, where by construction it is impossible for prices to boom indefinitely.

Suggested Citation

  • Doblas-Madrid, Antonio, 2016. "A finite model of riding bubbles," Journal of Mathematical Economics, Elsevier, vol. 65(C), pages 154-162.
    • Handle: RePEc:eee:mateco:v:65:y:2016:i:c:p:154-162
    DOI: 10.1016/j.jmateco.2015.06.009
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    Cited by:

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    2. Zeno Enders & Hendrik Hakenes, 2021. "Market Depth, Leverage, and Speculative Bubbles," Journal of the European Economic Association, European Economic Association, vol. 19(5), pages 2577-2621.
    3. Ripamonti, Alexandre & Silva, Diego & Moreira Neto, Eurico, 2018. "Asset Pricing and Asymmetric Information," MPRA Paper 87403, University Library of Munich, Germany.
    4. Asako, Yasushi & Funaki, Yukihiko & Ueda, Kozo & Uto, Nobuyuki, 2020. "(A)symmetric information bubbles: Experimental evidence," Journal of Economic Dynamics and Control, Elsevier, vol. 110(C).
    5. Ludovic Tangpi & Shichun Wang, 2022. "Optimal Bubble Riding: A Mean Field Game with Varying Entry Times," Papers 2209.04001, arXiv.org, revised Jan 2024.
    6. Ludovic Tangpi & Shichun Wang, 2023. "Optimal Bubble Riding with Price-dependent Entry: a Mean Field Game of Controls with Common Noise," Papers 2307.11340, arXiv.org.
    7. Liu, Feng & Conlon, John R., 2018. "The simplest rational greater-fool bubble model," Journal of Economic Theory, Elsevier, vol. 175(C), pages 38-57.

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