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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. Harrison Hong & David Sraer, 2012. "Quiet Bubbles," NBER Working Papers 18547, National Bureau of Economic Research, Inc.
  2. Jean Tirole & Emmanuel Farhi, 2011. "Bubbly Liquidity," 2011 Meeting Papers 1081, Society for Economic Dynamics.
  3. 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.
  4. 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.
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  8. 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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  11. Mishkin, F S., 2008. "How should we respond to asset price bubbles?," Financial Stability Review, Banque de France, issue 12, pages 65-74, October.
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  16. Allen, F. & Gale, D., 1991. "Limited Market Participation and Volatility of Asset Prices," Weiss Center Working Papers 2-92, Wharton School - Weiss Center for International Financial Research.
  17. Markus K Brunnermeier, 2002. "Bubbles and Crashes," FMG Discussion Papers dp401, Financial Markets Group.
  18. 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.
  19. 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.
  20. Allen, Franklin & Gale, Douglas, 2000. "Bubbles and Crises," Economic Journal, Royal Economic Society, vol. 110(460), pages 236-55, January.
  21. 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.
  22. Frederic S. Mishkin, 2011. "Monetary Policy Strategy: Lessons from the Crisis," NBER Working Papers 16755, National Bureau of Economic Research, Inc.
  23. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
  24. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
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  26. 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.
  27. Franklin Allen & Gary Gorton, 1993. "Churning Bubbles," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 813-836.
  28. Hajime Miyazaki, 1977. "The Rat Race and Internal Labor Markets," Bell Journal of Economics, The RAND Corporation, vol. 8(2), pages 394-418, Autumn.
  29. Gadi Barlevy & Jonas D. M. Fisher, 2010. "Mortgage choices and housing speculation," Working Paper Series WP-2010-12, Federal Reserve Bank of Chicago.
  30. 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.
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  32. 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.
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  35. 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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