Knowledge, Interest Rates, and Asset Price Bubbles

Daniel Stephenson ()
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Daniel Stephenson: Department of Economics, VCU School of Business

No 2301, Working Papers from VCU School of Business, Department of Economics

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.

JEL-codes: C73 D80 D84 E30 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2023-01
New Economics Papers: this item is included in nep-knm
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