Limited enforcement, bubbles and trading in incomplete markets

Camelia Bejan and Florin Bidian

MPRA Paper from University Library of Munich, Germany

Abstract: Rational bubbles are believed to be fragile and unable to explain the trading frenzy associated to price run-ups. With limited enforcement of credit contracts and endogenous debt limits designed to prevent default and allow for maximal credit expansion, a large class of bubbles can be introduced in asset prices by appropriately tightening agents' debt limits. By not affecting consumption, these bubbles are ideally suited to explain a variety of asset pricing puzzles. They can generate large increases in trade volume until they crash. Nonpositivity of debt limits restricts the potential for bubble injections to assets in zero supply or to equilibria with an infinite present value of aggregate endowment. Such equilibria are common in economies with limited enforcement, where interest rates are low to induce debt repayment (Bidian and Bejan 2012).

Keywords: rational bubbles; limited enforcement; trade volume; equity premium puzzle; endogenous debt limits (search for similar items in EconPapers)
JEL-codes: E44 E50 G12 (search for similar items in EconPapers)
Date: 2010-06-01, Revised 2012-02-20
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Citations: View citations in EconPapers (2)

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