Speculative Bubbles under Supply Constraints, Background Risk and Investment Fraud in the Art Market

57 Pages Posted: 27 Feb 2019 Last revised: 18 Sep 2020

See all articles by Alejandro Bernales

Alejandro Bernales

Universidad de Chile

Lorenzo Reus

Universidad Adolfo Ibanez

Víctor Valdenegro

University of Chile

Date Written: September 15, 2020

Abstract

We examine the unexplored effects on art markets of artist death (asset supply constraints), collectors' wealth (background risk) and forgery risk (risk of investment fraud), under short-sale constraints and risk aversion. Speculative bubbles emerge and have the form of an option strangle (a put option and a call option), in which strike prices are affected by art supply constraints and the association of the artworks' emotional value with both collectors' wealth and forgery, while the options' underlying asset is the stochastic heterogeneous beliefs of agents. We show that speculative bubbles increase with four elements: art supply constraints; a more negative correlation between collectors' wealth and the artworks' emotional value; a more positive relationship between forgery and the artworks' emotional value; and more heterogeneous beliefs. These four sources of speculation increase the expected turnover rate; however, they also augment the variance of speculative bubbles, which generates price discounts (i.e. risk premiums) for holding artworks. Consequently, the net impact of speculation is not necessarily increased art prices. This study not only contributes to the art market literature, but also to studies about speculative bubbles in other financial markets under heterogeneous beliefs, short-sale constraints and risk-averse investors, since we additionally consider the simultaneous effect of asset supply constraints, investors’ background risk and the risk of investment fraud.

Keywords: Art Markets, Speculative Bubbles, Investment Fraud, Background Risk, Asset Supply Constraints

JEL Classification: D84; G11; G12; K42; Z11

Suggested Citation

Bernales, Alejandro and Reus, Lorenzo and Valdenegro, Víctor, Speculative Bubbles under Supply Constraints, Background Risk and Investment Fraud in the Art Market (September 15, 2020). Available at SSRN: https://ssrn.com/abstract=3336282 or http://dx.doi.org/10.2139/ssrn.3336282

Alejandro Bernales (Contact Author)

Universidad de Chile ( email )

Diagonal Paraguay 257
Santiago
Chile

HOME PAGE: http://www.alejandrobernales.com

Lorenzo Reus

Universidad Adolfo Ibanez ( email )

Víctor Valdenegro

University of Chile ( email )

Pío Nono Nº1, Providencia
Santiago, R. Metropolitana 7520421
Chile

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