RESEARCH PAPERS

 WORKING PAPERS / IN PROGRESS

Rational Expectations Fools' Bubbles, with Luis Araujo

ABSTRACT: We develop a rational-expectations, Walrasian model of speculative bubbles, inspired by narratives of boom-bust episodes by Kindleberger (1978), Minsky (1986) and others. We model bubbles as wave-like market processes. Touched off by an initial shock, price booms are self-reinforcing early, but turn self-destructive later when prices surpass fundamental value. Previous models in this vein have been criticized, however, due to ad hoc features such as exogenous prices, as in Abreu and Brunnermeier (2003), or trading protocols that obstruct the informational role of prices, as in Doblas-Madrid (2012). Requiring agents to commit to trades before seeing the price raises legitimate criticisms on theoretical and empirical grounds. Our Walrasian model, free of such artificial hindrances, allays these concerns by relying only on multidimensional uncertainty to prevent bubble unraveling via backward induction. Standard market clearing, moreover, makes our bubble model considerably more compatible with the bulk of the macroeconomic and asset pricing literatures.

Finite Bubbles, Infinite Bubbles, and Crypto Assets, with Luis Araujo

ABSTRACT: We present a unified framework to study rational bubbles including infinite bubbles, as well as effectively finite, greater fool models of bubbles with asymmetric information. We furthermore show that a rational version of the framework developed by Abreu and Brunnermeier (2003) is a knife-edge case between the other two. We find that if dividends outgrow endowments, the model is effectively finite, whereas if they do not, bubbles must be infinite, even in the absence of common knowledge. Our model helps interpret recent dynamics in crypto markets, where equilibria in our model appear more plausible, relative to previous ones, some of which (finite rational and AB/DM) are utterly incompatible with zero dividend assets. Comparative statics are compatible with a lean-against-the-wind view that increase liquidity may be more conducive to bubbles.

Bubbles as Waves or Martingales: Evidence from Global Stock Markets, with Dooyeon Cho

ABSTRACT: In one literature, bubbles are infinite martingales without predictable patterns. In another, bubbles are finite wave-like processes: Self-reinforcing, then self-destructive. We contrast both notions against data for 36 countries. We find short-run momentum and mean reversion at multi-year horizons. Countries differ in their performance, but the overall correlation with a global index grows over time, especially during the 2008 crisis. Diversification benefits investors in most countries, except the US and Germany. In line with the boom-bust view, we find that low interest rates fuel equities, potentially inflating bubbles. US monetary policy impacts returns globally, even more than domestic policy.

Credit-Fuelled Bubbles, with Kevin J. Lansing

ABSTRACT: In the context of recent housing busts in the United States and other countries, many observers have highlighted the role of credit and speculation in fueling unsustainable booms that lead to crises. Motivated by these observations, we develop a model of credit-fuelled bubbles in which lenders accept risky assets as collateral. Booming prices allow lenders to extend more credit, in turn allowing investors to bid prices even higher. Eager to profit from the boom for as long as possible, asymmetrically informed investors fuel and ride bubbles, buying overvalued assets in hopes of reselling at a profit to a greater fool. Lucky investors sell the bubbly asset at peak prices to unlucky ones, who buy in hopes that the bubble will grow at least a bit longer. In the end, unlucky investors suffer losses, default on their loans, and lose much of their collateral to lenders. The model has implications for macro-financial regulation, as higher interest rates and lower lending limits are shown to reduce or even eliminate bubbles.

Bubbles and Banks, with Raoul Minetti

PUBLISHED  PAPERS

A Finite Model of Riding Bubbles, Journal of Mathematical Economics. 2016. Vol. 65, pp. 154-62.

Trade Intensity and Purchasing Power Parity, with Dooyeon Cho, Journal of International Economics. 2014. Vol. 93(1), pp. 194-209.

Business Cycle Accounting East and West: Asian Finance and the Investment Wedge, with Dooyeon Cho, Review of Economic Dynamics. 2013. Vol. 16(4), pp. 724-744. 

Sharing Information in the Credit Market: Contract-Level Evidence from U.S. Firms, with Raoul Minetti, Journal of Financial Economics. 2013. Vol. 109(1), pp. 198-223. 

A Robust Model of Bubbles with Multidimensional Uncertainty, Econometrica. 2012, Vol. 80(5), pp. 1845-93. 

Fiscal Trends and Self-Fulfilling Crises, Review of International Economics. 2009. Vol. 17(1), pp. 187-204. 

Understanding Business Cycles through Credit and Lease Contracts, with Raoul Minetti. Journal of Equipment Lease Financing. 2009.  Vol. 27(1), pp. 1-6.

Implications of Within-Period Timing in Models of Speculative Attack, Economics Bulletin. 2007. Vol. 6, No. 28 pp. 1-10.

________________________________________________________________________________