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Speculative bubbles and financial crisis

  • Pengfei Wang
  • Yi Wen

Why are asset prices so much more volatile and so often detached from their fundamentals? Why does the burst of financial bubbles depress the real economy? This paper addresses these questions by constructing an infinite-horizon heterogeneous-agent general-equilibrium model with speculative bubbles. We show that agents are willing to invest in asset bubbles even though they have positive probability to burst. We prove that any storable goods, regardless of their intrinsic values, may give birth to bubbles with market prices far exceeding their fundamental values. We also show that perceived changes in the bubbles probability to bust can generate boom-bust cycles and produce asset price movements that are many times more volatile than the economy's fundamentals, as in the data.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2009-029.

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Date of creation: 2009
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Handle: RePEc:fip:fedlwp:2009-029
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  1. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
  2. Patrick-Antoine Pintus & Yi Weng, 2009. "Leveraged financing, over investment, and boom-bust cycles," Working Papers halshs-00439245, HAL.
  3. Emmanuel Farhi & Jean Tirole, 2008. "Competing Liquidities: Corporate Securities, Real Bonds and Bubbles," NBER Working Papers 13955, National Bureau of Economic Research, Inc.
  4. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-20, April.
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  1. Speculative Bubbles and Financial Crises (AEJ:MA 2012) in ReplicationWiki

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