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A leverage-based model of speculative bubbles

  • Gadi Barlevy

This paper develops an equilibrium model of speculative bubbles that can be used to explore the role of various policies in either giving rise to or eliminating the possibility of asset bubbles, e.g. restricting the use of certain types of loan contracts, imposing down- payment restrictions, and changing inter-bank rates. As in previous work by Allen and Gorton (1993) and Allen and Gale (2000), a bubble arises in the model because traders are assumed to purchase assets with borrowed funds. My model adds to this literature by allowing creditors and traders to enter into a more general class of contracts, as well as by allowing speculators to trade strategically.

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Paper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-08-01.

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Date of creation: 2008
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Handle: RePEc:fip:fedhwp:wp-08-01
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  1. Christian Hellwig & Aleh Tsyvinski & Elias Albagli, 2012. "A theory of asset prices based on heterogeneous information," 2012 Meeting Papers 394, Society for Economic Dynamics.
  2. Franklin Allen & Douglas Gale, 2000. "Asset Price Bubbles and Monetary Policy," Center for Financial Institutions Working Papers 01-26, Wharton School Center for Financial Institutions, University of Pennsylvania.
  3. Frederic S. Mishkin, 2011. "Monetary Policy Strategy: Lessons from the Crisis," NBER Working Papers 16755, National Bureau of Economic Research, Inc.
  4. Simon H. Kwan, 2000. "Margin requirements as a policy tool?," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue mar24.
  5. J. Michael Harrison & David M. Kreps, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, Oxford University Press, vol. 92(2), pages 323-336.
  6. Peter Temin & Joachim Voth, 2004. "Riding the South Sea bubble," Economics Working Papers 861, Department of Economics and Business, Universitat Pompeu Fabra.
  7. 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.
  8. Harrison Hong & David Sraer, 2012. "Quiet Bubbles," NBER Working Papers 18547, National Bureau of Economic Research, Inc.
  9. Dilip Abreu & Markus K. Brunnermeier, 2003. "Bubbles and Crashes," Econometrica, Econometric Society, vol. 71(1), pages 173-204, January.
  10. Rocheteau, Guillaume & Wright, Randall, 2013. "Liquidity and asset-market dynamics," Journal of Monetary Economics, Elsevier, vol. 60(2), pages 275-294.
  11. Jose A. Scheinkman & Wei Xiong, 2003. "Overconfidence and Speculative Bubbles," Journal of Political Economy, University of Chicago Press, vol. 111(6), pages 1183-1219, December.
  12. Hajime Miyazaki, 1977. "The Rat Race and Internal Labor Markets," Bell Journal of Economics, The RAND Corporation, vol. 8(2), pages 394-418, Autumn.
  13. Nishant Dass & Massimo Massa & Rajdeep Patgiri, 2008. "Mutual Funds and Bubbles: The Surprising Role of Contractual Incentives," Review of Financial Studies, Society for Financial Studies, vol. 21(1), pages 51-99, January.
  14. Kocherlakota, Narayana R., 1992. "Bubbles and constraints on debt accumulation," Journal of Economic Theory, Elsevier, vol. 57(1), pages 245-256.
  15. Jean Tirole & Emmanuel Farhi, 2011. "Bubbly Liquidity," 2011 Meeting Papers 1081, Society for Economic Dynamics.
  16. Antonio Doblas‐Madrid, 2012. "A Robust Model of Bubbles With Multidimensional Uncertainty," Econometrica, Econometric Society, vol. 80(5), pages 1845-1893, 09.
  17. Manuel S. Santos & Michael Woodford, 1993. "Rational Asset Pricing Bubbles," Working Papers 9304, Centro de Investigacion Economica, ITAM.
  18. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
  19. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sérgio, 2011. "Understanding Booms and Busts in Housing Markets," CEPR Discussion Papers 8232, C.E.P.R. Discussion Papers.
  20. Olivier J. Blanchard & Mark W. Watson, 1982. "Bubbles, Rational Expectations and Financial Markets," NBER Working Papers 0945, National Bureau of Economic Research, Inc.
  21. Gadi Barlevy & Jonas D. M. Fisher, 2010. "Mortgage choices and housing speculation," Working Paper Series WP-2010-12, Federal Reserve Bank of Chicago.
  22. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
  23. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  24. Andrew B. Abel & N. Gregory Mankiw & Lawrence H. Summers & Richard J. Zeckhauser, 1989. "Assessing Dynamic Efficiency: Theory and Evidence," Review of Economic Studies, Oxford University Press, vol. 56(1), pages 1-19.
  25. 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, vol. 66, pages 467.
  26. Mishkin, F S., 2008. "How should we respond to asset price bubbles?," Financial Stability Review, Banque de France, issue 12, pages 65-74, October.
  27. Franklin Allen & Gary Gorton, 1993. "Churning Bubbles," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 813-836.
  28. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
  29. Gale, D. & Allen, F., 1991. "Limited Market Participation and Volatility of Asset Prices," Weiss Center Working Papers 14-91, Wharton School - Weiss Center for International Financial Research.
  30. Allen F. & Morris S. & Postlewaite A., 1993. "Finite Bubbles with Short Sale Constraints and Asymmetric Information," Journal of Economic Theory, Elsevier, vol. 61(2), pages 206-229, December.
  31. Wanda Mimra & Achim Wambach, 2011. "A Game-Theoretic Foundation for the Wilson Equilibrium in Competitive Insurance Markets with Adverse Selection," CESifo Working Paper Series 3412, CESifo Group Munich.
  32. Allen, Franklin & Gale, Douglas, 2000. "Bubbles and Crises," Economic Journal, Royal Economic Society, vol. 110(460), pages 236-55, January.
  33. repec:spr:pharme:v:22:y:2004:i:4:p:225-244 is not listed on IDEAS
  34. John R. Conlon, 2004. "Simple Finite Horizon Bubbles Robust to Higher Order Knowledge," Econometrica, Econometric Society, vol. 72(3), pages 927-936, 05.
  35. Spence, Michael, 1978. "Product differentiation and performance in insurance markets," Journal of Public Economics, Elsevier, vol. 10(3), pages 427-447, December.
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