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Rational Asset Pricing Bubbles Revisited

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  • Jan Werner

    (University of Minnesota)

Abstract

Price bubble arises when the price of an asset exceeds the asset's fundamental value, that is, the present value of future dividend payments. The important result of Santos and Woodford (1997) says that price bubbles cannot exist in equilibrium in the standard dynamic asset pricing model with rational agents as long as assets are in strictly positive supply and the present value of total future resources is finite. This paper explores the possibility of asset price bubbles when either one of the sufficient conditions for non-existence of bubbles is violated. We demonstrate that there always exist equilibria with price bubbles on assets in zero supply. Further, we show that endogenous debt constraints generated by limited enforcement of trade are in a certain sense most prone to give rise to equilibrium price bubbles on assets in strictly positive supply and with infinite present value of total resources.

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  • Jan Werner, 2012. "Rational Asset Pricing Bubbles Revisited," 2012 Meeting Papers 1165, Society for Economic Dynamics.
  • Handle: RePEc:red:sed012:1165
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    File URL: https://economicdynamics.org/meetpapers/2012/paper_1165.pdf
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    References listed on IDEAS

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    1. Kocherlakota, Narayana, 2008. "Injecting rational bubbles," Journal of Economic Theory, Elsevier, vol. 142(1), pages 218-232, September.
    2. Kocherlakota, Narayana R., 1992. "Bubbles and constraints on debt accumulation," Journal of Economic Theory, Elsevier, vol. 57(1), pages 245-256.
    3. Magill, Michael & Quinzii, Martine, 1996. "Incomplete markets over an infinite horizon: Long-lived securities and speculative bubbles," Journal of Mathematical Economics, Elsevier, vol. 26(1), pages 133-170.
    4. Christian Hellwig & Guido Lorenzoni, 2009. "Bubbles and Self-Enforcing Debt," Econometrica, Econometric Society, vol. 77(4), pages 1137-1164, July.
    5. Florin Bidian & Camelia Bejan, 2015. "Martingale properties of self-enforcing debt," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 60(1), pages 35-57, September.
    6. LeRoy,Stephen F. & Werner,Jan, 2014. "Principles of Financial Economics," Cambridge Books, Cambridge University Press, number 9781107024120, February.
    7. 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, June.
    8. 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.
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