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Bubbles, Banks, and Financial Stability

  • Kosuke Aoki

    (Faculty of Economics, University of Tokyo)

  • Kalin Nikolov

    (European Central Bank)

This paper asks two main questions: (1) What makes some asset price bubbles more costly for the real economy than others? and (2) When do costly bubbles occur? We construct a model of rational bubbles under credit frictions and show that when bubbles held by banks burst this is followed by a costly financial crisis. In contrast, bubbles held by ordinary savers have relatively muted effects. Banks tend to invest in bubbles when financial liberalisation decreases their profitability.

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Paper provided by Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo in its series CARF F-Series with number CARF-F-253.

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Length: 57 pages
Date of creation: Aug 2011
Date of revision:
Handle: RePEc:cfi:fseres:cf253
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