Speculative Bubbles and Financial Crisis

Asset prices are widely believed to be much more volatile and often detached from their fundamentals. It is also widely believed that the bursting of \u85nancial bubbles can depress the real economy. This paper addresses these issues by constructing an in\u85nite-horizon incomplete-market general-equilibrium model with speculative bubbles. We characterize conditions under which storable goods, regardless of their intrinsic values, can carry bubbles and agents are willing to invest in such bubbles despite their positive probability of bursting. We show that systemic risk perceived changes in the bubblesprobability to burst can generate boom-bust cycles with hump-shaped output dynamics, and produce asset price movements that are many times more volatile than the economys fundamentals, as in the data