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How Low Interest Rates Discern the Bubbles Nature: Leveraged vs Unleveraged Bubble

Jacopo Bonchi and Francesco Lucidi

No 12/20, Working Papers from Sapienza University of Rome, DISS

Abstract: Leveraged asset price bubbles, i.e., periods of boom-bust phases in asset prices accompanied by credit overhangs, are more harmful than unleveraged ones, in terms of financial and price stability. As bubbles are difficult to detect in real-time data, early researches focused on the macroeconomic conditions exacerbating the bubbles' nature. What kind of bubble is likely to emerge in an economy characterized by slow growth and a low real interest rate? This paper shows why the leveraged bubble is the answer to this question. First, we show that a negative real rate is sufficient for leveraged bubbles to emerge but not for unleveraged ones, in a stylized OLG model with incomplete credit markets and income inequality. Second, we show that this result holds empirically for post-World War II bubbles in advanced economies.

Keywords: low interest rates; leveraged bubbles; unleveraged bubbles (search for similar items in EconPapers)
JEL-codes: E43 E44 (search for similar items in EconPapers)
Date: 2020-06
New Economics Papers: this item is included in nep-mac
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