Noisy Rational Bubbles

54 Pages Posted: 22 Sep 2015 Last revised: 10 Apr 2018

Qiusha Peng

Fanhai International School of Finance, Fudan University; School of Economics, Fudan University

Date Written: March 30, 2018

Abstract

This paper develops a theory of asset price dynamics during extreme market episodes. In the model, noise trading breaks the winner's curse and leads to systematic overpricing. Over time, returns from resale opportunities diminish as learning proceeds, and asset prices tend to fall toward the fundamentals. Importantly, however, investors also update their expectations regarding the average precision of new information. This mechanism works to drive prices farther away from the intrinsic value. Finally, the model also allows for endogenous investor inflows that greatly amplify price movements. The model can produce various price episodes.

Keywords: Bubble-like price dynamics, Uncertainty, Investor flows, Noisy rational expectations equilibrium

JEL Classification: D82, G12, G14

Suggested Citation

Peng, Qiusha, Noisy Rational Bubbles (March 30, 2018). Available at SSRN: https://ssrn.com/abstract=2663561 or http://dx.doi.org/10.2139/ssrn.2663561

Qiusha Peng (Contact Author)

Fanhai International School of Finance, Fudan University ( email )

School of Economics, Fudan University ( email )

600 GuoQuan Road
Shanghai, 200433
China

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