Bubbles and Crises

98-01

Posted: 11 Feb 1998

See all articles by Franklin Allen

Franklin Allen

Imperial College London

Douglas M. Gale

New York University (NYU) - Department of Economics

Date Written: November 1997

Abstract

Bubbles where asset prices rise and then collapse are often followed by financial crises where default is widespread. A simple theory of bubbles based on an agency problem is developed. Investors use money borrowed from banks to invest. Risky assets are relatively attractive because investors can default in low payoff states so there is asset substitution and prices are bid up. The overall level of asset prices depends on the amount of credit. Risk can originate in both the real and financial sectors. Financial fragility occurs when credit expansion might be insufficient to ensure asset prices are high enough to prevent default.

JEL Classification: G12

Suggested Citation

Allen, Franklin and Gale, Douglas M., Bubbles and Crises (November 1997). 98-01. Available at SSRN: https://ssrn.com/abstract=58674

Franklin Allen (Contact Author)

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Douglas M. Gale

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10011
United States
(212) 998-8944 (Phone)
(212) 995-3932 (Fax)

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