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Rational Belief Bubbles

Author

Listed:
  • H. Sohn

    (ETH Zürich)

  • Didier Sornette

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

Abstract

We propose an extension of the class of rational expectations bubbles (REBs) to the more general rational beliefs setting of \cite{Kurz:1994,Kurz:1994a}. 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 \citet{Kurz:2011}.

Suggested Citation

  • H. Sohn & Didier Sornette, 2020. "Rational Belief Bubbles," Swiss Finance Institute Research Paper Series 20-05, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2005
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    More about this item

    Keywords

    Asset pricing; Bubbles; Ecient markets; Rational expectations; Rational Beliefs; Aggregation; Heterogeneous expectations; Correlated beliefs;
    All these keywords.

    JEL classification:

    • B20 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - General
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • G00 - Financial Economics - - General - - - General

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