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A liquidity-based model for asset price bubbles


  • Robert A. Jarrow
  • Philip Protter
  • Alexandre F. Roch


We provide a new liquidity-based model for financial asset price bubbles that explains bubble formation and bubble bursting. The martingale approach to modeling price bubbles assumes that the asset's market price process is exogenous and the fundamental price, the expected future cash flows under a martingale measure, is endogenous. In contrast, we define the asset's fundamental price process exogenously and asset price bubbles are endogenously determined by market trading activity. This enables us to generate a model that explains both bubble formation and bubble bursting. In our model, the quantity impact of trading activity on the fundamental price process—liquidity risk—is what generates price bubbles. We study the conditions under which asset price bubbles are consistent with no arbitrage opportunities and we relate our definition of the fundamental price process to the classical definition.

Suggested Citation

  • Robert A. Jarrow & Philip Protter & Alexandre F. Roch, 2012. "A liquidity-based model for asset price bubbles," Quantitative Finance, Taylor & Francis Journals, vol. 12(9), pages 1339-1349, August.
  • Handle: RePEc:taf:quantf:v:12:y:2012:i:9:p:1339-1349
    DOI: 10.1080/14697688.2011.620976

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    Cited by:

    1. Robert A. Jarrow, 2015. "Asset Price Bubbles," Annual Review of Financial Economics, Annual Reviews, vol. 7(1), pages 201-218, December.
    2. Nneji, Ogonna, 2015. "Liquidity shocks and stock bubbles," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 35(C), pages 132-146.
    3. Samuel N. Cohen & Lukasz Szpruch, 2011. "A limit order book model for latency arbitrage," Papers 1110.4811,
    4. Francesca Biagini & Andrea Mazzon & Thilo Meyer-Brandis, 2016. "Liquidity induced asset bubbles via flows of ELMMs," Papers 1611.01440,, revised Nov 2016.
    5. Chui-Chun Tsai & Tsun-Siou Lee, 2017. "Liquidity-Adjusted Value-at-Risk for TWSE Leverage/ Inverse ETFs: A Hellinger Distance Measure Research," Journal of Economics and Management, College of Business, Feng Chia University, Taiwan, vol. 13(1), pages 53-81, February.
    6. Robert Jarrow & Hao Li, 2014. "The impact of quantitative easing on the US term structure of interest rates," Review of Derivatives Research, Springer, vol. 17(3), pages 287-321, October.

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