IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Why Bubble-Bursting Is Unpredictable: Welfare Effects Of Anti-Bubble Policy When Central Banks Make Mistakes

  • Kai, Guo
  • Conlon, John R.

This paper examines the effect of bubble-bursting policy in the case where the central bank sometimes tries to deflate an asset which is not, in fact, overpriced. We consider the case of a “semi-bubble,” where some traders know that an asset is overpriced, but others do not. Unlike most previous papers on bubble policy, our framework assumes rational traders. We also assume a finite time horizon, to rule out infinite horizon type bubbles. The market’s “fulfilled expectations” equilibria are derived, and standard tools of welfare economics are applied to evaluate the effect of anti-bubble policy. Under the assumption that the announcements of the financial authority can help less informed traders to learn more about a risky asset, market equilibria are presented and compared. We show that, if sellers care relatively more about the states where the central bank makes a negative bubble-bursting announcement, an announcement policy interferes with the asset’s ability to share risks. Conversely, if sellers care relatively less about the announcement states, an announcement policy improves risk sharing. “Information leakage” plays an important role in our analysis. Because of this leakage, central bank announcements can initiate further information revelation between traders. That is, the leakage effect can reveal information that the central bank, itself, does not have. However, this information leakage may not be welfare improving. Also, this leakage effect makes it difficult to predict the effects of bubble-bursting policy. This may complicate both private investment strategies and public policy analysis.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://mpra.ub.uni-muenchen.de/5927/1/MPRA_paper_5927.pdf
File Function: original version
Download Restriction: no

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 5927.

as
in new window

Length:
Date of creation: Oct 2007
Date of revision:
Handle: RePEc:pra:mprapa:5927
Contact details of provider: Postal: Schackstr. 4, D-80539 Munich, Germany
Phone: +49-(0)89-2180-2219
Fax: +49-(0)89-2180-3900
Web page: http://mpra.ub.uni-muenchen.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.:

as in new window
  1. Alexander, Gordon J. & Peterson, Mark A., 2008. "The effect of price tests on trader behavior and market quality: An analysis of Reg SHO," Journal of Financial Markets, Elsevier, vol. 11(1), pages 84-111, February.
  2. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 77-128.
  3. Stiglitz, Joseph E, 1990. "Symposium on Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 13-18, Spring.
  4. Bordo, Michael D & Jeanne, Olivier, 2002. "Boom-Busts in Asset Prices, Economic Instability and Monetary Policy," CEPR Discussion Papers 3398, C.E.P.R. Discussion Papers.
  5. Markus K Brunnermeier, 2002. "Bubbles and Crashes," FMG Discussion Papers dp401, Financial Markets Group.
  6. John R. Conlon, 2004. "Simple Finite Horizon Bubbles Robust to Higher Order Knowledge," Econometrica, Econometric Society, vol. 72(3), pages 927-936, 05.
  7. Hirshleifer, Jack, 1971. "The Private and Social Value of Information and the Reward to Inventive Activity," American Economic Review, American Economic Association, vol. 61(4), pages 561-74, September.
  8. Larry Samuelson, 2004. "Modeling Knowledge in Economic Analysis," Journal of Economic Literature, American Economic Association, vol. 42(2), pages 367-403, June.
  9. Eli Ofek & Matthew Richardson, 2003. "DotCom Mania: The Rise and Fall of Internet Stock Prices," Journal of Finance, American Finance Association, vol. 58(3), pages 1113-1138, 06.
  10. 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.
  11. Peter Temin & Hans-Joachim Voth, 2004. "Riding the South See Bubble," Working Papers 213, Barcelona Graduate School of Economics.
  12. Owen Lamont, 2004. "Go Down Fighting: Short Seller vs. Firms," Yale School of Management Working Papers amz2521, Yale School of Management, revised 01 Aug 2004.
  13. Jonathan McCarthy & Richard W. Peach, 2004. "Are home prices the next "bubble"?," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 1-17.
  14. Stephen G. Cecchetti & Hans Genberg & Sushil Wadhwani, 2002. "Asset Prices in a Flexible Inflation Targeting Framework," NBER Working Papers 8970, National Bureau of Economic Research, Inc.
  15. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
  16. Harrison, J Michael & Kreps, David M, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, MIT Press, vol. 92(2), pages 323-36, May.
  17. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
  18. Cecchetti, Stephen G. & Kashyap, Anil K, 1996. "International cycles," European Economic Review, Elsevier, vol. 40(2), pages 331-360, February.
  19. John Conlon, 2005. "Should Central Banks Burst Bubbles?," Game Theory and Information 0508007, EconWPA.
  20. D'Avolio, Gene, 2002. "The market for borrowing stock," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 271-306.
  21. Karl E. Case & Robert J. Shiller, 2003. "Is There a Bubble in the Housing Market?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(2), pages 299-362.
  22. Alexander, Gordon J. & Peterson, Mark A., 1999. "Short Selling on the New York Stock Exchange and the Effects of the Uptick Rule," Journal of Financial Intermediation, Elsevier, vol. 8(1-2), pages 90-116, January.
  23. Christopher Kent & Philip Lowe, 1997. "Asset-price Bubbles and Monetary Policy," RBA Research Discussion Papers rdp9709, Reserve Bank of Australia.
  24. Milgrom, Paul & Stokey, Nancy, 1982. "Information, trade and common knowledge," Journal of Economic Theory, Elsevier, vol. 26(1), pages 17-27, February.
  25. 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.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:5927. 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: (Ekkehart Schlicht)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.