scholarly journals Market Depth, Leverage, and Speculative Bubbles

2021 ◽  
Author(s):  
Zeno Enders ◽  
Hendrik Hakenes
Keyword(s):  
Rational Expectations ◽  
Asset Price ◽  
Limited Liability ◽  
Capital Requirements ◽  
Future Price ◽  
Market Size ◽  
Rational Bubbles ◽  
Market Depth ◽  
Fundamental Value ◽  
Risk Free Rate

Abstract We develop a model of rational bubbles based on leverage and the assumption of an imprecisely known maximum market size. In a bubble, traders push the asset price above its fundamental value in a dynamic way, driven by rational expectations about future price developments. At a previously unknown date, the bubble will endogenously burst. Households optimally decide whether to lend to traders with limited liability. Bubbles increase welfare of the initial asset holders, but reduce welfare of future households. We provide general conditions for the possibility of bubbles depending on uncertainty about market size, traders’ degree of leverage, and the risk-free rate. This allows us to discuss several policy measures. Capital requirements and a correctly implemented Tobin tax can prevent bubbles. Implemented incorrectly, however, these measures may create the possibility of bubbles and can reduce welfare.

The Micro and Macro of Managerial Beliefs

2020 ◽  
Author(s):  
Jose Maria Barrero
Keyword(s):  
Rational Expectations ◽  
Asset Price ◽  
Heterogeneous Firms ◽  
Adjustment Costs ◽  
Consumer Welfare ◽  
Sales Growth ◽  
Firm Level ◽  
Managerial Decisions ◽  
Managerial Beliefs ◽  
Growth Volatility

This paper studies how biases in managerial beliefs affect managerial decisions, firm performance, and the macroeconomy. Using a new survey of US managers I establish three facts. (1) Managers are not over-optimistic: sales growth forecasts on average do not exceed realizations. (2) Managers are overprecise (overconfident): they underestimate future sales growth volatility. (3) Managers overextrapolate: their forecasts are too optimistic after positive shocks and too pessimistic after negative shocks. To quantify the implications of these facts, I estimate a dynamic general equilibrium model in which managers of heterogeneous firms use a subjective beliefs process to make forward-looking hiring decisions. Overprecision and overextrapolation lead managers to overreact to firm-level shocks and overspend on adjustment costs, destroying 2.1 percent of the typical firm’s value. Pervasive overreaction leads to excess volatility and reallocation, lowering consumer welfare by 0.5 to 2.3 percent relative to the rational expectations equilibrium. These findings suggest overreaction may amplify asset-price and business cycle fluctuations.

scholarly journals Capital requirements, risk-taking and welfare in a growing economy

2021 ◽  
Author(s):  
Pierre-Richard Agénor ◽  
Luiz A. Pereira da Silva
Keyword(s):  
Risk Taking ◽  
Default Risk ◽  
Limited Liability ◽  
Capital Requirements ◽  
Optimal Choice ◽  
Capital Adequacy ◽  
Financial Supervision ◽  
Capital Adequacy Ratio ◽  
Monitoring Effort ◽  
Growing Economy

AbstractThe effects of capital requirements on risk-taking and welfare are studied in an overlapping generations model of endogenous growth with banking, limited liability, and government guarantees. Capital producers face a choice between a safe technology and a risky, more productive but socially inefficient, technology. Bank risk-taking is endogenous. As a result of a skin in the game effect—motivated either as an aggregate externality, or as the outcome of the optimal choice of monitoring effort by individual banks—default risk is inversely related to the capital adequacy ratio. Numerical simulations show that in an equilibrium where banks extend both safe and risky loans, the skin in the game effect must be sufficiently strong for a welfare-maximizing regulatory policy to exist. These results remain qualitatively similar with endogenous monitoring costs and a strong effect of monitoring on entrepreneurial moral hazard. However, numerical experiments also suggest that the optimal capital adequacy ratio may be too high in practice and may require concomitantly a broadening of the perimeter of regulation and a strengthening of financial supervision to prevent disintermediation and distortions in financial markets.

scholarly journals Emergent volatility in asset markets with heterogeneous agents

2001 ◽  
Vol 6 (3) ◽  
pp. 171-180 ◽  
Author(s):  
Honggang Li ◽  
J. Barkley Rosser
Keyword(s):  
Heterogeneous Agents ◽  
Moving Average ◽  
Asset Price ◽  
Market Price ◽  
Switching Behavior ◽  
Asset Markets ◽  
Technical Trading Rules ◽  
Market Participants ◽  
Fundamental Value ◽  
Discrete Formulation

This paper examines the emergence of complex volatility in dynamic asset markets when there are heterogeneous agents. A discrete formulation is studied with two categories of market participants, fundamentalist traders who buy when the asset price is below the fundamental value and sell when it is above and noise traders who use moving average technical trading rules that can lead them to chase trends. Agents switch from one type of strategy to the other according to relative returns. A variety of outcomes are studied using numerical simulation, including variation of market price responsiveness to changes in excess demand, in switching behavior, and the introduction of noise. Bifurcation analysis of certain parameters is presented.

scholarly journals An Experimental Test of the Lucas Asset Pricing Model

2018 ◽  
Vol 86 (2) ◽  
pp. 627-667 ◽  
Author(s):  
Sean Crockett ◽  
John Duffy ◽  
Yehuda Izhakian
Keyword(s):  
Asset Pricing ◽  
Asset Price ◽  
Consumption Smoothing ◽  
Asset Price Bubbles ◽  
Price Bubbles ◽  
Fundamental Value ◽  
Experimental Treatments ◽  
Marginal Returns ◽  
Dynamic Asset Pricing ◽  
Fundamental Price

Abstract We implement a dynamic asset pricing experiment in the spirit of Lucas (1978) with storable assets and non-storable cash. In the first treatment, we impose diminishing marginal returns to cash to incentivize consumption smoothing across periods. We find that subjects use the asset to smooth consumption, although the asset trades at a discount relative to the risk-neutral fundamental price. This under-pricing is a departure from the asset price “bubbles” observed in the large experimental asset pricing literature originating with Smith et al. (1988) and can be rationalized by considering subjects’ risk aversion with respect to uncertain money earnings. In a second treatment, with no induced motivation for trade à la the Smith et al. design, we find that the asset trades at a premium relative to its expected value and that shareholdings are highly concentrated. Elimination of asset price uncertainty in additional experimental treatments serves to reinforce the same observations, and suggests that speculative behaviour explains the departure of prices from fundamental value in the absence of a consumption-smoothing motive for asset trades.

Monetary Policy and Asset Price Gap Signal Technology in a New Keynesian Framework

2021 ◽  
Vol 0 (0) ◽  
Author(s):  
Alexander Mislin
Keyword(s):  
Inflation Rate ◽  
Asset Price ◽  
New Keynesian ◽  
Adjustment Process ◽  
Keynesian Model ◽  
Nominal Rate ◽  
Dynamic Stochastic ◽  
The Difference ◽  
Fundamental Value ◽  
Output Gaps

Abstract This article develops a New Keynesian model in which the inflation rate depends on the present value of future output gaps and asset prices gaps. The latter follows a price adjustment process. These asset price gaps are driven by ‛asset price gap signal technology’, a measure of exponentially distributed asset price gaps with a signalling mechanism. Within a dynamic stochastic optimisation approach, I identify a policy rule for the central bank in which the asset price gap the difference between the actual asset price at time t to its fundamental value plays a crucial role in determining the nominal rate of interest.

Fundamental Value Hypothesis and Return Behavior: Evidence from Emerging Equity Markets

2006 ◽  
Vol 09 (01) ◽  
pp. 97-127 ◽  
Author(s):  
Benjamas Jirasakuldech ◽  
Riza Emekter ◽  
Peter Went
Keyword(s):  
Rational Expectations ◽  
Equity Markets ◽  
The Philippines ◽  
Duration Dependence ◽  
Test Results ◽  
Time Reversibility ◽  
Return Behavior ◽  
Price Patterns ◽  
Fundamental Value ◽  
Fundamental Values

This study examines the return behavior of 15 emerging equity markets for persistent deviations from the fundamental value hypothesis. The duration dependence test shows that rational expectations bubble do not cause deviations from fundamental value in any of the markets. Markov chain test results imply that markets in China, Malaysia, the Philippines, and Singapore deviate from their fundamental values due to non-random price changes. A price decrease is more likely to follow two periods of price decrease in these four equity markets. Finally, time reversibility test reveals that all equity markets, except for Jordan and Egypt, exhibit asymmetrical price patterns, suggesting departures from fundamental values.

INEFFICIENT BUBBLES AND EFFICIENT DRAWDOWNS IN FINANCIAL MARKETS

2020 ◽  
Vol 23 (07) ◽  
pp. 2050047 ◽  
Author(s):  
MICHAEL SCHATZ ◽  
DIDIER SORNETTE
Keyword(s):  
Rational Expectations ◽  
Rational Expectation ◽  
Asset Price ◽  
Theoretical Background ◽  
Local Martingale ◽  
Management Problem ◽  
Market Failures ◽  
Asset Price Bubbles ◽  
Price Bubbles ◽  
Hyman Minsky

At odds with the common “rational expectations” framework for bubbles, economists like Hyman Minsky, Charles Kindleberger and Robert Shiller have documented that irrational behavior, ambiguous information or certain limits to arbitrage are essential drivers for bubble phenomena and financial crises. Following this understanding that asset price bubbles are generated by market failures, we present a framework for explosive semimartingales that is based on the antagonistic combination of (i) an excessive, unstable pre-crash process and (ii) a drawdown starting at some random time. This unifying framework allows one to accommodate and compare many discrete and continuous time bubble models in the literature that feature such market inefficiencies. Moreover, it significantly extends the range of feasible asset price processes during times of financial speculation and frenzy and provides a strong theoretical background for future model design in financial and risk management problem settings. This conception of bubbles also allows us to elucidate the status of rational expectation bubbles, which, by design, suffer from the paradox that a rational market should not allow for misvaluation. While the discrete time case has been extensively discussed in the literature and is most criticized for its failure to comply with rational expectations equilibria, we argue that this carries over to the finite time “strict local martingale”-approach to bubbles.

Exchange rate bubbles: Fundamental value estimation and rational expectations test

2012 ◽  
Vol 31 (5) ◽  
pp. 1033-1059 ◽  
Author(s):  
Wilfredo L. Maldonado ◽  
Octávio A.F. Tourinho ◽  
Marcos Valli
Keyword(s):  
Exchange Rate ◽  
Rational Expectations ◽  
Value Estimation ◽  
Fundamental Value
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