Bubbles and Credit Constraints

Abstract:     
We provide an infinite-horizon model of a production economy with bubbles, in which firms meet stochastic investment opportunities and face credit constraints. Capital is not only an input for production, but also serves as collateral. We show that bubbles on this reproducible asset may arise, which relax collateral constraints and improve investment efficiency. The collapse of bubbles leads to a recession. We show that there is a credit policy that can eliminate the bubble on firm assets and can achieve the efficient allocation.

Number of Pages in PDF File: 37

Keywords: Bubbles, Collateral Constraints, Credit Policy, Asset Price, Arbitrage, Q Theory, Liquidity

JEL Classification: E44, G12, G18

working papers series