Rational Belief Bubbles

43 Pages Posted: 5 Feb 2020

See all articles by H. Sohn

H. Sohn

ETH Zürich

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute

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Date Written: February 2, 2020

Abstract

We propose an extension of the class of rational expectations bubbles (REBs) to the more general rational beliefs setting of Kurz (1994a,b). In a potentially non-stationary but stationarizable environment, among an heterogenous population of agents, it is possible to hold more than one "rational" expectation. When rational but diverse beliefs converge ("correlated beliefs"), they do not cancel each other out in aggregate anymore. This can make them an object of rational speculation. Accounting for the fact that market efficiency has an intrinsic time dimension, we show that diverse but correlated beliefs can thus account for speculative bubbles, without the need for irrational agents or limits to arbitrage. Many of the shortcomings of REBs that make rational bubbles implausible can be overcome once we relax the ergodicity requirement. In particular, we argue that the hitherto unexplained "bubble component" of REBs corresponds to an extension of the state space in Kurz and Motolese (2011).

Keywords: Asset pricing, Bubbles, Ecient markets, Rational expectations, Rational Beliefs, Aggregation, Heterogeneous expectations, Correlated beliefs

JEL Classification: B20, D53, D58, D81, D83, D84, D85, E13, G00

Suggested Citation

Sohn, H. and Sornette, Didier, Rational Belief Bubbles (February 2, 2020). Swiss Finance Institute Research Paper No. 20-05. Available at SSRN: https://ssrn.com/abstract=3530895 or http://dx.doi.org/10.2139/ssrn.3530895

H. Sohn

ETH Zürich ( email )

Zürich, 8092
Switzerland

Didier Sornette (Contact Author)

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
Switzerland
41446328917 (Phone)
41446321914 (Fax)

HOME PAGE: http://www.er.ethz.ch/

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