Rational Bubbles Research Articles

Credit Growth, Rational Bubbles and Economic Efficiency

Excessive credit growth and the emergence of bubbles increase the likelihood of a systemic crisis. While no causality between credit growth and systemic crises has been empirically established, it seems reasonable to think that excessive credit growth goes hand in hand with the emergence of bubbles and that it is their bursting that triggers a systemic crisis. This article explores the interaction between the demand for bubbly assets and the supply of credit in a dynamic overlapping generations economy and examines the macroprudential policy implications.

Classic rational bubbles and representativeness

The aim of this work is to describe a model of representative bubbles with infinitely lived agents that is accessible to a general audience. In particular, we shall compare this formalization of behavioral bubble dynamics with the classic rational one. The key role of the transversality condition for rational models will be clear, and we will discuss the necessity of its fulfillment when agents are not rational and arbitrageurs are faced with limited arbitrage possibilities. We shall analyze in detail what kind of nonrationality is taken into account and how it triggers bubbly dynamics. It will be plain that representative bubbles can explain the presence of bubbles even when rational models are not able to detect them.

The Macroeconomics of Rational Bubbles: A User's Guide

This review provides a guide to macroeconomic applications of the theory of rational bubbles. It shows that rational bubbles can be easily incorporated into standard macroeconomic models and illustrates how they can be used to account for important macroeconomic phenomena. It also discusses the welfare implications of rational bubbles and the role of policy in managing them. Finally, it provides a detailed review of the literature.

Rational Speculative Bubbles: Evidence from Asian Stock Markets

We scrutinize China, Hong Kong, Indonesia, Japan, Malaysia, Philippines, South Korea, Taiwan, and Thailand for the presence of rational bubbles by employing several tests on a large dataset that includes three bubble episodes. We also convert most tests into recursive to overcome structural breaks in the data that improve a bubble’s detection. The unit root tests exhibit bubbles in all markets while the sup augmented Dickey-Fuller test suggests Hong Kong, Japan, and Thailand exhibit an explosive process. The cointegration tests show that Hong Kong, Japan, Malaysia, and Thailand may have bubbles while the explosiveness test shows evidence of bubbles in all markets for both weekly and monthly data. However, the duration dependence test identifies bubbles in six (two) Asian markets for weekly (monthly) returns. Thus, our results suggest that the rational bubble tests are enhanced from recursive tests using a large dataset that includes multiple bubble episodes.

Wealth Preference and Rational Bubbles

We consider a neoclassical economy where households derive utility from holding wealth. We show that, under some conditions, there can be rational bubbles. Hence, we provide a microfoundation for bubbles that relies on a frictionless infinite-horizon economy without any heterogeneity across households. While our bubbly equilibria are very similar to those obtained by Tirole (1985) in an overlapping generation economy, the underlying economics is different. Turning to public debt, we show that Ponzi schemes can be sustainable. Hence, in general, the limit on the accumulation of public debt by the government is not given by its no-Ponzi condition but, instead, by the representative household’s transversality condition. The Ricardian equivalence must hold in any of our equilibria. Finally, in the presence of money, the real equilibrium structure of the economy remains unchanged. We carefully investigate the effects of helicopter drops of money on the possibility of Ponzi schemes and of speculative hyperinflation or deflation.

Wealth Preference and Rational Bubbles

We consider a neoclassical economy where households derive utility from holding wealth. We show that, under some conditions, there can be rational bubbles. Hence, we provide a microfoundation for bubbles that relies on a frictionless infinite-horizon economy without any heterogeneity across households. While our bubbly equilibria are very similar to those obtained by Tirole (1985) in an overlapping generation economy, the underlying economics is different. Turning to public debt, we show that Ponzi schemes can be sustainable. Hence, in general, the limit on the accumulation of public debt by the government is not given by its no-Ponzi condi-tion but, instead, by the representative household’s transversality condition. The Ricardian equivalence must hold in any of our equilibria. Finally, in the presence of money, the real equilibrium structure of the economy remains unchanged. We carefully investigate the effects of helicopter drops of money on the possibility of Ponzi schemes and of speculative hyperinflation or deflation.

Asset Pricing Bubbles Under Rational Expectations

The Efficiency Market Hypotheses (EMH) imply rational investors and no asset mispricing in the medium run. This paper critically evaluates on the point of whether an asset price bubble is an irrational phenomenon that cannot be detected. Thereby, I review the existing literature and reflect on asset pricing tests to detect bubbles. I show that the emergence of rational bubbles within the EMH framework is indeed possible as long as a number of assumptions is not violated. As researchers show, these assumption do not hold in practice, which means that rational bubbles can be ruled out. Thus, a bubbles is always an irrational phenomenon that can be explained with behavioural models such as feedback trading and herding. This implies that EMH does not hold. Hence, irrational bubbles can only emerge in inefficient markets. Models trying to detect bubbles fail to identify the existence of bubbles ex ante and ex interim. Ex post, they can prove that a bubble had existed.

On the Inception of Financial Representative Bubbles

In this work, we aim to formalize the inception of representative bubbles giving the condition under which they may arise. We will find that representative bubbles may start at any time, depending on the definition of a behavioral component. This result is at odds with the theory of classic rational bubbles, which are those models that rely on the fulfillment of the transversality condition by which a bubble in a financial asset can arise just at its first trade. This means that a classic rational bubble (differently from our model) cannot follow a cycle since if a bubble exists, it will burst by definition and never arise again.

Prevention and landing of bubble

By replacing assumptions on the satisfaction of the transversality condition with introducing capital gains taxes, transaction or property taxes, rebate options, and fixed periods of asset usage, rational bubble is shown to be preventable. For an existing bubble, hard- and soft-landings are shown to be possible. Hard landing is defined by a bubble which crashes via financial or tax tools, while soft landing is defined as an increasing bubble reaching some stable value via taxes. Japan, U.S., and Greece experienced real estate bubbles and hard landings, while Taiwan ended its real estate bubble in the 1980s with a soft landing.

Cointegrated Periodically Collapsing Bubbles in the Exchange Rate of “BRICS”

ABSTRACTWe test the occurrence of periodically recurring rational bubbles in the exchange rate of each of the “BRICS” countries currency relative to the US dollar. The forward exchange rate is used as a proxy for the expected exchange rate, different Purchasing Parity Power (PPP)-based rules for the fundamental exchange rate are considered, and its initial value is endogenously determined. For the chosen model, the regime switching equation satisfactorily fits the data, confirming the presence of rational bubbles for all countries. The dynamics of the exchange rate series for each country is interpreted with the help of the estimated bubbles. The bubbles are compared across countries, found to be cointegrated, and this is interpreted as evidence of the international transmission of exchange rate shocks between these countries.

A note on effects of rational bubble on portfolios

In general, demand increases in wealth and decreases in price in microeconomics. We thereby propose a completely different perspective. By establishing expected utility function of investors, this article introduces one rational bubble asset and one bubble free asset in portfolios and focuses on the effects of bubble on investment portfolios from wealth and price perspectives. All conclusions are obtained by theoretical analysis with microeconomics theory. We argue that inferior goods and Giffen behavior can occur for the bubble free asset in microeconomic fields. The results can help investors to recognize bubble assets and bubble free assets more scientifically. Both bubble and bubble free assets can be inferior goods under some conditions, so we cannot to say which asset better than the other one absolutely.

Bubbles on the Steppe: Intrinsic Bubbles and Credit Expansion in Kazakhstan's Real Estate Market

This paper uses high frequency aggregate housing price data from 2000 through 2017 for the minerals-rich former Soviet republic of Kazakhstan to explore price movements during boom and stagnation cycles. Kazakhstan experienced staggeringly rapid housing price growth at the outset of this period, when real prices for existing housing rose more than ten-fold in a seven-year period. Despite this rise (and subsequent decline by roughly one-third), it appears that bubble components as variously measured were small for new housing, and largely limited to 2002-04. A far larger bubble appears for sales of existing units, but unrecorded renovation expenditures may be pushing this term up. However, co-movement with vast credit expansion leads us to conclude that there is not enough evidence to support the rational speculative bubble model in Kazakhstan during 2000-2017, but we do find evidence for a policy-induced boom. What was not small was the huge rise in real housing wealth (and its likely contribution to aggregate demand) or the roughly 40% rise in housing stock that occurred during 2003-15. We conclude that credit expansion, housing wealth, and housing construction are far more important at least to a class of upper-middle-income countries than is generally appreciated.

Rational bubbles in a monetary economy

Abstract This study explores rational bubbles in a monetary economy using an endogenous growth model with status seeking. Rational bubbles may arise when the money growth rate is higher than some threshold level. In a bubbly economy, a higher money growth rate leads to a larger bubble size, while the monetary policy is super-neutral. However, in a bubbleless economy, the monetary policy is non-neutral. Based on a comparative analysis of the calibrated model, I argue that an optimal monetary policy that maximizes the social welfare of a bubbleless economy may trigger bubbles and hurt the economy.

Testing for bubbles in the art markets: An empirical investigation

The market for artworks emerged about ten years ago and seems to have coincided with a rapid increase in the number of participants and record-breaking prices. This raises the question of whether this market is experiencing a rational bubble or not. In this paper, we apply a battery of tests to detect explosive behavior in the art markets from 1998 to 2015. According to the Markov Switching ADF test, two regimes exist for all the indices, but no bubble is found. However, applying the right- tailed ADF, we detect more than one bubble with most of the bubbles happening in the period 2002–2005. Then, accounting for the volatility shifts, we apply the bootstrap tests and find similar results. We argue that the market has been going through some adjustment after the 2008 financial crisis and becoming more sensitive to economic and geopolitical events, with the artworks demonstrating a level of maturity similar to other alternative investment classes. Our findings have important implications in recognizing the cause of bubbles and to take steps in reducing their impact on the economy.

Asset bubbles and efficiency in a generalized two-sector model

We consider a multi-sector infinite-horizon general equilibrium model. The issues of equilibrium existence, efficiency, and bubble emergence are addressed. We show how different assets give rise to different rational bubbles. We also point out that efficient bubbly equilibria may exist.

Testing for explosive bubbles in the South African-US exchange rate using the sequential ADF procedures

This paper tests for the existence of speculative bubbles in the South African-US exchange rate using the sequential ADF procedures. In particular, the paper uses the SADF and GSADF right-tailed unit root tests to explore the existence of explosive bubbles in the South African-US exchange rate for the time period running from January1980 through July 2012. The results provide evidence in support of the existence of explosive bubbles in the nominal rand-dollar exchange rate, the real exchange rate of traded and non-traded goods. The explosive behavior exhibited by the South African rand-US dollar exchange rate can be interpreted as evidence of rational bubbles given that this behavior is driven by the fundamentals including relative prices of traded and non-traded goods.

Testing bubbles in housing markets: An analysis from the panel-cointegrated model for the Brazilian states

Este artigo tem o propósito de verificar se há indícios de bolhas racionais nos preços das habitações dos estados brasileiros (São Paulo, Rio de Janeiro, Pernambuco, Ceará, Bahia e Minas Gerais), no período de 2008 a 2015. Essa análise será realizada a partir o método de cointegração em dados de painel proposto por Pedroni (2004). Os resultados mostraram que não há suporte empírico para uma relação de cointegração entre os preços reais das habitações e o aluguel, dando indícios de bolhas nos preços das habitações no nível local. Esse resultado está em conformidade com os encontrados por Mendonça & Sachsida (2012) e Besarria (2014), sendo que esses autores analisaram a economia agregada. Por fim, evidências baseadas nos testes de causalidade de Granger em dados de painel sugerem que as alterações dos preços da habitação são úteis na previsão de mudanças no valor dos aluguéis e a relação inversa não foi verificada, corroborando com a hipótese proposta pelo modelo de bolha racional.

Monetary Policy, Inflation and Rational Asset Price Bubbles

Empirical evidence points to moderate inflation during stock market booms. To explain it and study optimal monetary policy in such a situation, this paper develops a dynamic model with rational bubbles and nominal rigidities. The model features a financial cost channel through which the shadow cost of borrowing affects the marginal cost. A bubble-led boom mitigates firms' borrowing constraints and keeps inflation from rising by decreasing the shadow cost of borrowing. In this situation Ramsey-optimal monetary policy calls for tightening to curb the boom. Strict inflation targeting is counterproductive in the short run as it exacerbates the boom. For obtaining these results the financial cost channel and nominal wage rigidity are essential.

CHOQUES NOS PREÇOS DOS ATIVOS E A DINÂMICA DAS DECISÕES DE POLÍTICA MACROECONÔMICA: UMA ANÁLISE DA RESPOSTA FISCAL E MONETÁRIA A UMA BOLHA HABITACIONAL

O objetivo deste artigo é investigar os indícios de bolhas racionais nos preços das habitações e analisar os efeitos dos choques nos preços desses ativos nos instrumentos de política monetária e fiscal. A discussão sobre bolhas se limita à análise dos preços das habitações e seus dividendos por meio de testes de cointegração linear e com quebra estrutural. Os resultados sugerem que há indícios de bolhas no mercado habitacional brasileiro. A discussão subsequente avalia os efeitos desse choque no comportamento das séries da inflação, PIB real, consumo das famílias, taxa Selic, receita e despesa governamental, mercado de trabalho e financiamento habitacional, por meio do modelo de vetores autorregressivos. Em suma, observa-se que a bolha estimula a atividade fiscal em um comportamento pró-cíclico. Por outro lado, se verifica que a política monetária, buscando estabilizar a inflação e o produto, tem levado em consideração os possíveis efeitos desestabilizadores causados pela bolha.

How Predictable? Rent Growth and Returns in Sydney and Melbourne Housing Markets

We construct rent-price ratios for houses and units in 82 local government areas in the Sydney and Melbourne markets for the period 1985/86-2015. Using this annual data we employ long-horizon regression techniques and find that rent-price ratios (i.e. rental yields) have predictive content for both future real housing returns and future growth rates of real rents. However rents and returns have greater predictability in Sydney than in Melbourne. Using a variance decomposition for the rent-price ratio implied by the present-value model, we find that variation in rental yields of units in Sydney is almost fully accounted for by expected changes in future rent growth and returns. There appears to be no role for rational bubbles in influencing the prices of Sydney units. In contrast – on average – lesser portions of the variance in rental yields on houses in Sydney (two thirds) and Melbourne (one third) and units in Melbourne (60 percent) is explained by expected future returns and rents. Evidently there is scope for (stochastic) rational bubbles to have affected these markets. Our results point to an important difference between the behaviour of residential housing markets and stock markets. In the stock market, current changes in dividend-price ratios do not appear to reflect important variations in future dividend growth. Our results for Sydney and Melbourne suggest that current changes in rent-price ratios do signal future changes in rent growth.