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Decisions in Economics and Finance

01-02-2018

Classic rational bubbles and representativeness

Authors: Massimiliano Ferrara, Bruno Antonio Pansera, Francesco Strati

Published in: Decisions in Economics and Finance

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Abstract

The aim of this work is to describe a model of representative bubbles with infinitely lived agents that is accessible to a general audience. In particular, we shall compare this formalization of behavioral bubble dynamics with the classic rational one. The key role of the transversality condition for rational models will be clear, and we will discuss the necessity of its fulfillment when agents are not rational and arbitrageurs are faced with limited arbitrage possibilities. We shall analyze in detail what kind of nonrationality is taken into account and how it triggers bubbly dynamics. It will be plain that representative bubbles can explain the presence of bubbles even when rational models are not able to detect them.

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Footnotes
1
“...Our test exploits a unique feature of housing markets in the UK and Singapore, where property ownership takes the form of either very long-term leaseholds or freeholds. Leaseholds are finite-maturity, pre-paid, and tradeable ownership contracts, often with initial maturities of 999 years, while freeholds are infinite-maturity ownership contracts...We estimate the price difference between freeholds and extremely long leaseholds to obtain a direct estimate of the price of the bubble claim and test whether it is indeed positive...”(Giglio et al. 2016, p. 1049)
 
2
See Kamihigashi (1998) for a pathological case in which, in a standard model, if the utility function is unbounded below, then a bubble can arise since the stochastic Euler equation may be violated.
 
3
Finest common coarsening of \(\mathscr {P}_i\), a partition whose cells are the smallest public events.
 
4
Linda is 31 years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations. Which is more probable?
  • Linda is a bank teller
  • Linda is a bank teller and is active in the feminist movement.
 
5
It is a symmetric function of representativeness of types \(a\ne k\)
$$\begin{aligned} \theta \equiv \theta \Bigg (\frac{\pi _{a,\Gamma }}{\pi _{a,\Gamma ^c}} ; \bigg (\frac{\pi _{k,\Gamma }}{\pi _{k,\Gamma ^c}}\bigg )_{k\in \Omega \setminus \{\omega \}} \Bigg ) \end{aligned}$$
in which \(\theta \) is weakly increasing in its first argument, while it is weakly decreasing in the other arguments \(k\in \Omega \setminus \{\omega \}\) (see Bordalo et al. 2016 for details).
 
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Metadata
Title
Classic rational bubbles and representativeness
Authors
Massimiliano Ferrara
Bruno Antonio Pansera
Francesco Strati
Publication date
01-02-2018
Publisher
Springer International Publishing
Published in
Decisions in Economics and Finance
Print ISSN: 1593-8883
Electronic ISSN: 1129-6569
DOI
https://doi.org/10.1007/s10203-018-0205-4