Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/174929 
Year of Publication: 
2017
Series/Report no.: 
CESifo Working Paper No. 6806
Publisher: 
Center for Economic Studies and ifo Institute (CESifo), Munich
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’ decision to lend to traders with limited liability in a bubble is endogenous. Bubbles reduce welfare of future investors. 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.
Subjects: 
bubbles
rational expectations
market size
liquidity
financial crises
leveraged investment
capital structure
JEL: 
E44
G01
G12
Document Type: 
Working Paper
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