The Cycle of Rents: A Model of Rational Bull-and-Bear Cycles in an Efficient Market
UB Economics Working Papers E20/400
52 Pages Posted: 25 Jun 2020
Date Written: May 12, 2020
A widespread misbelief asserts that an efficient market would arbitrage out any cyclical or otherwise partially-predictable, non-random-walk pattern on the observed market prices time series. Hence, when such patterns are observed, they are often attributed to either irrational behavior or market inefficiency. Yet, strictly speaking, the efficient markets hypothesis only rules such patterns out of the expected (i.e. mean) path, whereas, if the probability diffusion process is asymmetric (as in most economic and financial stochastic models), the observed time series will approximate the median path, which is not subject to such constraint. This paper combines a general imperfect-competition production function specification (i.e. one generating economic rents) with the concept of time-to-build to develop a rational-expectations, efficient-markets model displaying a valuation cycle along its median path. This model may therefore help to explain the bull-and-bear cycles observed in asset markets generating economic rents e.g. real estate, commodities or, for that matter, most if not all of the assets quoted in the stock exchange.
Keywords: Business Cycles, Bull and Bear Markets, Financial Market Fluctuations, Economic Rents, Time to Build, Efficient Markets.
JEL Classification: E32, E44, G1, G12, G14.
Suggested Citation: Suggested Citation