Rational Belief Bubbles

H. Sohn and Didier Sornette
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H. Sohn: ETH Zürich
Didier Sornette: ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute

No 20-05, Swiss Finance Institute Research Paper Series from 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}.

Keywords: Asset pricing; Bubbles; Ecient markets; Rational expectations; Rational Beliefs; Aggregation; Heterogeneous expectations; Correlated beliefs (search for similar items in EconPapers)
JEL-codes: B20 D53 D58 D81 D83 D84 D85 E13 G00 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2020-02
New Economics Papers: this item is included in nep-mac, nep-mic and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2005

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