Negative Bubbles Under Short-Sales Constraints and Heterogeneous Beliefs

Abstract

In a dynamic trading model, investors with heterogeneous beliefs have an option to sell the stock now and buy it back later. Due to this repurchase option and the risk aversion of investors, it is possible for the stock price to be lower than the lowest valuation among investors even when the short-sales constraint is binding. This result contrasts that of Harrison and Kreps (1978) in which due to a resale option and risk neutrality, a bubble always arises. We also demonstrate that in a static model, there exists neither a bubble nor a negative bubble.

Keywords: Negative Bubbles, Short-Sales Constraints, Heterogeneous Beliefs

JEL Classification: G10, G12, G14