We present a simple yet fully rational general equilibrium model that highlights the fact that relative wealth concerns can play a role in explaining the presence and dynamics of financial “bubbles.” Because our model has a finite horizon, our explanation for the existence of bubbles is distinct from typical models of bubbles. We consider a finite-horizon overlapping generations model and show ...

Abstract We develop a model of rational bubbles based on leverage and the assumption an imprecisely known maximum market size. In bubble, traders push asset price above its fundamental value in dynamic way, driven by expectations about future developments. At previously unknown date, bubble will endogenously burst. Households optimally decide whether to lend with limited liability. Bubbles incr...

We study Dupire’s equation for local volatility models with bubbles. The equation for call options contains extra terms compared to the usual equation, whereas, surprisingly enough, the Dupire equation for put options does not contain any extra terms. We also note that uniqueness of solutions to the Dupire equation is lost in general, and we show how to single out the option price among all pos...

Hydrodynamics of multiple rising bubbles as a fundamental two-phase phenomenon is studied numerically by lattice Boltzmann method and using Lee two-phase model. Lee model based on Cahn-Hilliard diffuse interface approach uses potential form of intermolecular forces and isotropic finite difference discretization. This approach is able to avoid parasitic currents and leads to a stable procedure t...

A stylized theory of money and central banking is added to a model of competitive equilibrium in asset markets to explain the determination of the general level of asset prices and interest rates. The cash-in-advance constraint provides a transactions demand for money, but this is not sufficient to guarantee the determinacy of the price level if liquidity is costless or the price level is uncer...

This paper examines the effects of the most recent U.S. housing bubble on the fiscal policy of California cities. We use an instrumental variables approach that helps isolate fiscal consequences of house price appreciation by taking advantage of the influence of local topological constraints on the elasticity of house prices with respect to interest rates. Our analysis generates three main find...

We implement a dynamic asset pricing experiment in the spirit of Lucas (1978) with storable assets and non-storable cash. In one treatment we impose diminishing marginal returns to cash to incentivize consumption-smoothing across periods, while in a second treatment there is no induced motive for trade. In the former case we find that subjects use the asset to smooth consumption though the asse...

We propose a non linear Langevin equation as a model for stock market fluctuations and crashes. This equation is based on an identification of the different processes influencing the demand and supply, and their mathematical transcription. We emphasize the importance of feedback effects of price variations onto themselves. Risk aversion, in particular, leads to an ‘up-down’ symmetry breaking te...