Rational asset pricing bubbles and debt constraints |
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| Institution: | 1. CNRS (LEM, UMR 8179), France;2. Iéseg School of Management, 3 rue de la Digue, 59000 Lille, France;3. CORE (Université Catholique de Louvain), 34 voie du Roman Pays, 1348 Louvain-la-Neuve, Belgium;4. EM Lyon Business School, 23 avenue Guy de Collongue, 69134 Ecully Cedex, France;1. Department of Economics, Southern Methodist University and Federal Reserve Bank of Dallas, TX, 75275, USA;2. Federal Reserve Bank of Dallas, 2200 N, Pearl Street, Dallas, TX, 75201, USA;3. Department of Economics, Bowling Green State University, Bowling Green, OH, 43403, USA;1. Michigan State University, United States of America;2. Sao Paulo School of Economics-FGV, Brazil;3. Luiss University, Italy |
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| Abstract: | Rational 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 facing borrowing constraints 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 under endogenous debt constraints induced by limited enforcement of debt repayment. Equilibria with endogenous debt constraints are prone to have infinite present value of total resources. We show that asset price bubbles are likely to exist in such equilibria. Further, we demonstrate that there always exist equilibria with price bubbles on assets in zero supply. |
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| Keywords: | Rational pricing bubbles Debt constraints Default |
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