On the Inception of Rational Bubbles in Stock Prices
This paper analyzes the theoretical possibility of rational bubbles in stock prices in a model in which stockholders have infinite planning horizons and in which free disposal of equity rules out the existence of negative rational bubbles. The analysis shows that in this framework if a positive rational bubble exists, then it started on the first date of trading of the stock. Thus, the existence of a rational bubble at any date would imply that the stock has been overvalued relative to market fundamentals since the first date of trading and that prior to the first date of trading potential stockholders who anticipated the initial pricing of the stock expected that the stock would be overvalued relative to market fundamentals. The analysis also shows that any rational bubble will eventually burst and will not restart. Thus, even if a positive rational bubble exists, stockholders know that after a random, but almost surely finite, date the stock price will conform to market fundamentals forever.
|Date of creation:||Jul 1986|
|Date of revision:|
|Publication status:||published as Diba and Grossman, "The Theory of Rational Bubbles in Stock Prices," from Economic Journal, Vol. 98, No. 3, September 1988.|
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