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Imperfect knowledge, liquidity and bubbles

William Branch ()

Journal of Economic Dynamics and Control, 2016, vol. 62, issue C, 17-42

Abstract: Insufficient liquidity can lead to substantial movements in asset prices. There is a single asset traded in a centralized market that facilitates exchange in decentralized trade. If the asset is in short supply the price includes a liquidity premium. Traders have imperfect knowledge about future asset prices and estimate, in real-time, an econometric forecasting model. A permanent decrease in the supply of assets, or an increase in collateral requirements, can lead to over-shooting of the price. When price includes a liquidity premium there can be recurrent bubbles and crashes. Liquidity and adaptive learning play key roles in fitting the empirical distribution of price–dividend ratios.

Keywords: Asset pricing; Adaptive learning; Bubbles; Liquidity (search for similar items in EconPapers)
JEL-codes: D82 D83 E40 E50 (search for similar items in EconPapers)
Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:62:y:2016:i:c:p:17-42

DOI: 10.1016/j.jedc.2015.11.001

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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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