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Rational Asset Pricing Bubbles Revisited

  • Jan Werner

    (University of Minnesota)

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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Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 1165.

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Date of creation: 2012
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Handle: RePEc:red:sed012:1165
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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  1. 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.
  2. Narayana R. Kocherlakota, 2006. "Injecting Rational Bubbles," Levine's Bibliography 122247000000000905, UCLA Department of Economics.
  3. Kocherlakota, N.R., 1990. "Bubbles and Constraints on Debt Accumulation," Working Papers 90-29, University of Iowa, Department of Economics.
  4. 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.
  5. 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.
  6. Christian Hellwig & Guido Lorenzoni, 2006. "Bubbles and Self-Enforcing Debt," NBER Working Papers 12614, National Bureau of Economic Research, Inc.
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