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Asset Bubbles and Credit Constraints

Jianjun Miao () and Pengfei Wang ()

American Economic Review, 2018, vol. 108, issue 9, 2590-2628

Abstract: We provide a theory of rational stock price bubbles in production economies with infinitely lived agents. Firms meet stochastic investment opportunities and face endogenous credit constraints. They are not fully committed to repaying debt. Credit constraints are derived from incentive constraints in optimal contracts which ensure default never occurs in equilibrium. Stock price bubbles can emerge through a positive feedback loop mechanism and cannot be ruled out by transversality conditions. These bubbles command a liquidity premium and raise investment by raising the debt limit. Their collapse leads to a recession and a stock market crash.

JEL-codes: D25 E22 E32 E44 G12 G14 (search for similar items in EconPapers)
Date: 2018
Note: DOI: 10.1257/aer.20160782
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Handle: RePEc:aea:aecrev:v:108:y:2018:i:9:p:2590-2628