Bubbles refer to asset prices that exceed an asset’s fundamental value because current owners believe they can resell the asset at an even higher price. There are four main strands of models: (i) all investors have rational expectations and identical information, (ii) investors are asymmetrically informed and bubbles can emerge because their existence need not be commonly known, (iii) rational traders interact with behavioural traders and bubbles persist since limits to arbitrage prevent rational investors from eradicating the price impact of behavioural traders, (iv) investors hold heterogeneous beliefs, potentially due to psychological biases, and agree to disagree about the fundamental value.
KeywordsArbitrage Asset-pricing models Asymmetric information Autocorrelation Backward induction Bubbles Centipede game Central limit theorems Co-integration Efficient markets hypothesis Fiat money Gains from trade Hedge funds Limited liability Noise traders Overlapping generations model Rational expectations Risk aversion Transversality condition Unit roots
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