Rethinking Asset Bubbles: Reflections for the Age of Institutional Investing

43 Pages Posted: 10 Dec 2017

See all articles by Brad Jones

Brad Jones

International Monetary Fund (IMF); University of Cambridge - Judge Business School

Date Written: December 5, 2017

Abstract

Upon surveying a contentious topic that has occasioned much debate, this paper offers reflections on the likelihood that asset booms, bubbles and busts continue posing a threat to financial stability despite financial markets becoming increasingly informationally-efficient, complete, and heavily influenced by sophisticated (presumably rational) investors. Rather than arise from widespread behavioral irrationality as is commonly assumed, this paper suggests procyclical mispricings stand to increasingly reflect institutional frictions — benchmarking, incentive and organizational design pressures — in the rapidly-growing institutional investment industry. These influences may make bubble riding ‘rational,’ or at the very least, discourage institutions from leaning against the wind. Moreover, even in the absence of leverage, systemic risk could increasingly be shaped by large shifts in risk premia owing to the rational herding motivations of institutional investors. To the extent procyclicality owes less to ‘irrational exuberance’ and more to performance evaluation practices, traditional countercyclical policy measures could be of reduced efficacy unless reinforced by reforms to institutional incentives.

Keywords: Asset Bubbles; Limits to Arbitrage; Behavioral Biases, Financial Stability; Macroprudential Policy; Monetary Policy

JEL Classification: E44, E58, G01, G02, G12, G14, G18

Suggested Citation

Jones, Brad, Rethinking Asset Bubbles: Reflections for the Age of Institutional Investing (December 5, 2017). Available at SSRN: https://ssrn.com/abstract=3083036 or http://dx.doi.org/10.2139/ssrn.3083036

Brad Jones (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom

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