Representative bubbles and deleveraging

Francesco Strati

Review of Behavioral Finance, 2020, vol. 13, issue 5, 502-521

Abstract: Purpose - The causes for the formation of a bubble in the collateral market when agents are provided with homogeneous expectations are explored. This bubbly dynamics will define a sufficient condition for deleveraging. Design/methodology/approach - Theoretical approach with neutral deleveraging. Findings - Findings of the study are defined sufficient conditions for a behavioral rational bubble's formation in a market of collateral and the subsequent deleveraging. The crowd-in effect of the representative bubble is caused by errors in extrapolating information and thus by representativeness, while the crowd-out effect of deleveraging is set off by reverting to a rational heuristic. Research limitations/implications - The limit is that it is a homogeneous expectations approach, the implication is that cannot be rational speculation. Practical implications - Even in a simple model of homogeneous expectations a bubble may arise with serious effect on the demand side: models that detect just rational mispricings cannot account for behavioral components that have financial and real effects. Originality/value - The paper defines how deleveraging may occur even in case of homogeneous expectations. The latter should not be seen just as a limit but also as a signal of the importance of being aware of behavioral components.

Keywords: Bubbles; Collateral constraints; Financial crisis; Deleveraging; Diagnostic expectations; Stereotypes; D84; E44; E71; G4 (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:eme:rbfpps:rbf-03-2020-0053

DOI: 10.1108/RBF-03-2020-0053

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