Finite Bubbles with Short Sale Constraints and Asymmetric Information

Posted: 1 Sep 1999

See all articles by Franklin Allen

Franklin Allen

Imperial College London

Stephen Morris

MIT

Andrew Postlewaite

University of Pennsylvania - Department of Economics

Abstract

We present a finite period general equilibrium model of an exchange economy with asymmetric information. We say that a rational expectations equilibrium exhibits an expected bubble if the price of an asset in one period is higher than any agent's marginal valuation of holding the asset to maturity. We say the equilibrium exhibits a strong bubble if the price is higher than the dividend with probability one. We show that a necessary condition for an expected bubble to exist is that each agent must be short sale constrained at some period in the future with positive probability. We show that necessary conditions for a strong bubble to occur are that (1) each agent must have private information in the period and state in which the bubble occurs and (2) agents' trades are not common knowledge. We also present examples of rational expectations equilibria that exhibit strict bubbles when the necessary conditions are satisfied.

JEL Classification: G14

Suggested Citation

Allen, Franklin and Morris, Stephen Edward and Postlewaite, Andrew, Finite Bubbles with Short Sale Constraints and Asymmetric Information. Available at SSRN: https://ssrn.com/abstract=5893

Franklin Allen (Contact Author)

Imperial College London ( email )

South Kensington Campus
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Stephen Edward Morris

MIT ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

HOME PAGE: http://https://economics.mit.edu/faculty/semorris

Andrew Postlewaite

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-7350 (Phone)
215-573-2057 (Fax)

HOME PAGE: http://www.econ.upenn.edu/~apostlew

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