On the Existence and Prevention of Asset Price Bubbles
We develop a model of rational bubbles based on the assumptions of unknown market liquidity and limited liability of traders. In a bubble, the price of an asset rises dynamically above its steady-state value, justified by rational expectations about future price developments. The larger the expected future price increase, the more likely it is that the bubble will burst because market liquidity becomes exhausted. Depending on the interactions between uncertainty about market liquidity, fundamental riskiness of the asset, the compensation scheme of the fund manager, and the risk-free interest rate, we give a condition for whether rational bubbles are possible. Based on this analysis, we discuss several widely-discussed policy measures with respect to their effectiveness in preventing bubbles. A reduction of manager bonuses or a Tobin tax can create or eliminate the possibility of bubbles, depending on their implementation. Monetary policy and long-term compensation schemes can prevent bubbles.
|Date of creation:||Oct 2010|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: +49-(0)228 / 91416-0
Fax: +49-(0)228 / 91416-55
Web page: http://www.coll.mpg.de/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Hui Ou-Yang, 2003. "Optimal Contracts in a Continuous-Time Delegated Portfolio Management Problem," Review of Financial Studies, Society for Financial Studies, vol. 16(1), pages 173-208.
When requesting a correction, please mention this item's handle: RePEc:mpg:wpaper:2010_44. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marc Martin)
If references are entirely missing, you can add them using this form.