IDEAS home Printed from https://ideas.repec.org/p/vcu/wpaper/2302.html
   My bibliography  Save this paper

Knowledge, Interest Rates, and Asset Price Bubbles

Author

Listed:
  • Daniel Graydon Stephenson

    (Department of Economics, VCU School of Business)

Abstract

An outcome is said to be rationalizable if it is consistent with the assumption that agents possess common knowledge of rationality. We show that shorter investment horizons and lower interest rates produce larger larger deviations from the unique rationalizable price path in continuous-time asset markets. If investors possess common knowledge of rationality, prices converge on fundamentals as quickly as possible. Conversely, if investors possess only finite order knowledge of rational- ity, prices exhibit bubbles and crashes that deviate from the rational- izable price path. Shorter investment horizons and lower interest rates are shown to amplify bubbles and crashes.

Suggested Citation

  • Daniel Graydon Stephenson, 2023. "Knowledge, Interest Rates, and Asset Price Bubbles," Working Papers 2301, VCU School of Business, Department of Economics.
    • Handle: RePEc:vcu:wpaper:2302
    as

    Download full text from publisher

    File URL: https://danielgstephenson.com/items/InterestRatesAndAssetPrices.pdf
    File Function: First version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. John R. Conlon, 2004. "Simple Finite Horizon Bubbles Robust to Higher Order Knowledge," Econometrica, Econometric Society, vol. 72(3), pages 927-936, May.
    2. Allen F. & Morris S. & Postlewaite A., 1993. "Finite Bubbles with Short Sale Constraints and Asymmetric Information," Journal of Economic Theory, Elsevier, vol. 61(2), pages 206-229, December.
    3. Aumann, Robert J., 1995. "Backward induction and common knowledge of rationality," Games and Economic Behavior, Elsevier, vol. 8(1), pages 6-19.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Qin, Jie, 2015. "A model of regret, investor behavior, and market turbulence," Journal of Economic Theory, Elsevier, vol. 160(C), pages 150-174.
    2. Enders, Zeno & Hakenes, Hendrik Hakenes, 2014. "On the Existence and Prevention of Speculative Bubbles," Working Papers 0567, University of Heidelberg, Department of Economics.
    3. John Conlon, 2005. "Should Central Banks Burst Bubbles?," Game Theory and Information 0508007, University Library of Munich, Germany.
    4. Ms. Anna Scherbina, 2013. "Asset Price Bubbles: A Selective Survey," IMF Working Papers 2013/045, International Monetary Fund.
    5. Dong, Feng & Jia, Yandong & Wang, Siqing, 2022. "Speculative Bubbles and Talent Misallocation," Journal of Economic Dynamics and Control, Elsevier, vol. 141(C).
    6. Zhang, Mu & Zheng, Jie, 2017. "A robust reference-dependent model for speculative bubbles," Journal of Economic Behavior & Organization, Elsevier, vol. 137(C), pages 232-258.
    7. Doblas-Madrid, Antonio, 2016. "A finite model of riding bubbles," Journal of Mathematical Economics, Elsevier, vol. 65(C), pages 154-162.
    8. Franklin Allen & Elena Carletti, 2013. "Systemic risk from real estate and macro-prudential regulation," International Journal of Banking, Accounting and Finance, Inderscience Enterprises Ltd, vol. 5(1/2), pages 28-48.
    9. Negrelli, Sara, 2020. "Bubbles and persuasion with uncertainty over market sentiment," Games and Economic Behavior, Elsevier, vol. 120(C), pages 67-85.
    10. Giglio, Stefano & Severo, Tiago, 2012. "Intangible capital, relative asset shortages and bubbles," Journal of Monetary Economics, Elsevier, vol. 59(3), pages 303-317.
    11. Brunnermeier, Markus K. & Oehmke, Martin, 2013. "Bubbles, Financial Crises, and Systemic Risk," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1221-1288, Elsevier.
    12. John R. Conlon, 2015. "Should Central Banks Burst Bubbles? Some Microeconomic Issues," Economic Journal, Royal Economic Society, vol. 125(582), pages 141-161, February.
    13. Feng Liu & Joseph S. White & John R. Conlon, 2023. "A Three‐State Rational Greater‐Fool Bubble Model With Intertemporal Consumption Smoothing," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 64(4), pages 1565-1594, November.
    14. Allen, Franklin & Carletti, Elena, 2013. "New theories to underpin financial reform," Journal of Financial Stability, Elsevier, vol. 9(2), pages 242-249.
    15. Makoto WATANABE & Yu Awaya & kohei Iwasaki, 2024. "Money is the roof of asset bubbles," CIGS Working Paper Series 24-001E, The Canon Institute for Global Studies.
    16. Kai, Guo & Conlon, John R., 2007. "Why Bubble-Bursting Is Unpredictable: Welfare Effects Of Anti-Bubble Policy When Central Banks Make Mistakes," MPRA Paper 5927, University Library of Munich, Germany.
    17. Knight, John & Satchell, Stephen & Srivastava, Nandini, 2014. "Steady state distributions for models of locally explosive regimes: Existence and econometric implications," Economic Modelling, Elsevier, vol. 41(C), pages 281-288.
    18. Carlos J. Perez & Manuel Santos, 2017. "On the Dynamics of Speculation in a Model of Bubbles and Manias," Working Papers 2017-02, University of Miami, Department of Economics.
    19. Zeno Enders & Hendrik Hakenes, 2021. "Market Depth, Leverage, and Speculative Bubbles," Journal of the European Economic Association, European Economic Association, vol. 19(5), pages 2577-2621.
    20. Barlevy, Gadi, 2014. "A leverage-based model of speculative bubbles," Journal of Economic Theory, Elsevier, vol. 153(C), pages 459-505.

    More about this item

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:vcu:wpaper:2302. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Oleg Korenok (email available below). General contact details of provider: https://edirc.repec.org/data/edvcuus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.