A Mathematical Theory of Financial Bubbles

Over the last 10 years or so a mathematical theory of bubbles has emerged, in the spirit of a martingale theory based on an absence of arbitrage, as opposed to an equilibrium theory. This paper attempts to explain the major developments of the theory as it currently stands, including equities, options, forwards and futures, and foreign exchange. It also presents the recent development of a theory of bubble detection. Critiques of the theory are presented, and a defense is offered. Alternative theories, especially for bubble detection, are sketched.

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