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A leverage-based model of speculative bubbles

  • Gadi Barlevy

This paper examines whether theoretical models of bubbles based on the notion that the price of an asset can deviate from its fundamental value are useful for understanding phenomena that are often described as bubbles, and which are distinguished by other features such as large and rapid booms and busts in asset prices together with high turnover in asset ownership. In particular, I focus on riskshifting models similar to those developed in Allen and Gorton (1993) and Allen and Gale (2000). I show that such models could explain these phenomena, and discuss under what conditions booms and speculative trading would emerge. In addition, I show that these models imply that speculative bubbles can be associated with low rather than high premia on loans, in accordance with observations on credit conditions during episodes in which asset prices boomed and crashed.

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Paper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-2011-07.

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Date of creation: 2011
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Handle: RePEc:fip:fedhwp:wp-2011-07
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  1. Peter Temin & Hans-Joachim Voth, 2004. "Riding the South See Bubble," Working Papers 213, Barcelona Graduate School of Economics.
  2. 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.
  3. Andrew Abel & Gregory N. Mankiw & Lawrence H. Summers & Richard Zeckhauser, . "Assessing Dynamic Efficiency: Theory and Evidence," Rodney L. White Center for Financial Research Working Papers 14-88, Wharton School Rodney L. White Center for Financial Research.
  4. Dilip Abreu & Markus K. Brunnermeier, 2003. "Bubbles and Crashes," Econometrica, Econometric Society, vol. 71(1), pages 173-204, January.
  5. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
  6. 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.
  7. Randall Wright & Guillaume Rocheteau, 2011. "Liquidity and Asset Market Dynamics," 2011 Meeting Papers 103, Society for Economic Dynamics.
  8. Gadi Barlevy & Jonas D. M. Fisher, 2010. "Mortgage choices and housing speculation," Working Paper Series WP-2010-12, Federal Reserve Bank of Chicago.
  9. Hong, Harrison & Sraer, David, 2013. "Quiet bubbles," Journal of Financial Economics, Elsevier, vol. 110(3), pages 596-606.
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  13. Emmanuel Farhi & Jean Tirole, 2011. "Bubbly Liquidity," NBER Working Papers 16750, National Bureau of Economic Research, Inc.
  14. Antonio Doblas‐Madrid, 2012. "A Robust Model of Bubbles With Multidimensional Uncertainty," Econometrica, Econometric Society, vol. 80(5), pages 1845-1893, 09.
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  17. Mishkin, F S., 2008. "How should we respond to asset price bubbles?," Financial Stability Review, Banque de France, issue 12, pages 65-74, October.
  18. 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.
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  26. repec:spr:pharme:v:22:y:2004:i:4:p:225-244 is not listed on IDEAS
  27. Kocherlakota, Narayana R., 1992. "Bubbles and constraints on debt accumulation," Journal of Economic Theory, Elsevier, vol. 57(1), pages 245-256.
  28. Olivier J. Blanchard & Mark W. Watson, 1982. "Bubbles, Rational Expectations and Financial Markets," NBER Working Papers 0945, National Bureau of Economic Research, Inc.
  29. Franklin Allen & Gary Gorton, 1993. "Churning Bubbles," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 813-836.
  30. 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.
  31. 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.
  32. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
  33. Spence, Michael, 1978. "Product differentiation and performance in insurance markets," Journal of Public Economics, Elsevier, vol. 10(3), pages 427-447, December.
  34. 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.
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  36. 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.
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