Rational asset pricing bubbles and portfolio constraints

This article shows that portfolio constraints can give rise to rational asset pricing bubbles in equilibrium even if there are unconstrained agents in the economy who can benefit from the induced limited arbitrage opportunities. Furthermore, it is shown that bubbles can lead to both multiplicity and real indeterminacy of equilibria. The general results are illustrated by two explicitly solved examples where seemingly innocuous portfolio constraints make bubbles a necessary condition for the existence of an equilibrium.

[1]  O. Blanchard,et al.  Speculative bubbles, crashes and rational expectations , 1979 .

[2]  Anna Pavlova,et al.  On Trees and Logs , 2002, J. Econ. Theory.

[3]  Mark A. Loewenstein,et al.  The Limits of Investor Behavior , 2006 .

[4]  Anna Pavlova,et al.  The Role of Portfolio Constraints in the International Propagation of Shocks , 2007 .

[5]  Roy Radner,et al.  Existence of Equilibrium of Plans, Prices, and Price Expectations in a Sequence of Markets , 1972 .

[6]  Manuel S. Santos,et al.  Rational asset pricing bubbles , 1997 .

[7]  J. Harrison,et al.  Martingales and stochastic integrals in the theory of continuous trading , 1981 .

[8]  Suleyman Basak,et al.  An Equilibrium Model with Restricted Stock Market Participation , 1997 .

[9]  Benjamin Croitoru,et al.  Equilibrium Mispricing in a Capital Market with Portfolio Constraints , 2000 .

[10]  Julien Hugonnier,et al.  Endogenous Completeness of Diffusion Driven Equilibrium Markets , 2012 .

[11]  D. Cuoco.  Optimal Consumption and Equilibrium Prices with Portfolio Constraints and Stochastic Income , 1997 .

[12]  M. Loewenstein,et al.  Options and Bubbles , 2007 .

[13]  R. Mehra,et al.  THE EQUITY PREMIUM A Puzzle , 1985 .

[14]  Robert Fernholz,et al.  Diversity and relative arbitrage in equity markets , 2008, Finance Stochastics.

[15]  Jakša Cvitanić,et al.  Convex Duality in Constrained Portfolio Optimization , 1992 .

[16]  M. Yor,et al.  The importance of strictly local martingales; applications to radial Ornstein–Uhlenbeck processes , 1999 .

[17]  Nicolae Gârleanu,et al.  Two Monetary Tools: Interest Rates and Haircuts , 2010, NBER Macroeconomics Annual.

[18]  Xiongzhi Chen.  Brownian Motion and Stochastic Calculus , 2008 .

[19]  L. Debnath.  Tables of Integral Transforms , 2012 .

[20]  P. Veronesi,et al.  Understanding Predictability , 2004, Journal of Political Economy.

[21]  T. Berrada,et al.  Bounded Rationality and Asset Pricing with Intermediate Consumption , 2009 .

[22]  M. Watson,et al.  Bubbles, Rational Expectations and Financial Markets , 1982 .

[23]  Hua He,et al.  Optimal Dynamic Trading Strategies with Risk Limits , 2001, Oper. Res..

[24]  L. Pedersen,et al.  Margin-Based Asset Pricing and Deviations from the Law of One Price , 2009 .

[25]  Anna Pavlova,et al.  Multiplicity in General Financial Equilibrium with Portfolio Constraints , 2008, J. Econ. Theory.

[26]  Tony Berrada,et al.  Bounded Rationality and Asset Pricing , 2006 .

[27]  Jérôme Detemple,et al.  Equilibrium Asset Prices and No-Arbitrage with Portfolio Constraints , 1997 .

[28]  Julien Hugonnier,et al.  Heterogenous Preferences and Equilibrium Trading Volume , 2006 .

[29]  Wei Xiong,et al.  Overconfidence and Speculative Bubbles , 2003, Journal of Political Economy.

[30]  Mark Loewenstein,et al.  Rational Equilibrium Asset-Pricing Bubbles in Continuous Trading Models , 2000, J. Econ. Theory.

[31]  Suleyman Basak,et al.  Asset Pricing with Heterogeneous Beliefs , 2004 .

[32]  E. Miller.  Risk, Uncertainty, and Divergence of Opinion , 1977 .

[33]  Julien Hugonnier,et al.  Heterogeneous preferences and equilibrium trading volume , 2007 .

[34]  P. Protter.  Stochastic integration and differential equations , 1990 .

[35]  Alex Shapiro,et al.  The Investor Recognition Hypothesis in a Dynamic General Equilibrium: Theory and Evidence , 1999 .

[36]  I. Karatzas,et al.  On optimal arbitrage , 2010, 1010.4987.

[37]  A. Erdélyi,et al.  Tables of integral transforms , 1955 .

[38]  David M. Kreps,et al.  Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations , 1978 .

[39]  Benjamin Croitoru,et al.  On the Role of Arbitrageurs in Rational Markets , 2004 .

[40]  Issouf Soumaré,et al.  International Risk Sharing, Investment Restrictions and Asset Prices , 2007 .

[41]  Leonard Rosenthal,et al.  The seemingly anomalous price behavior of Royal Dutch/Shell and Unilever N.V./PLC , 1990 .

[42]  R. Thaler,et al.  Anomalies: The Law of One Price in Financial Markets , 2003 .

[43]  D. Duffie.  Dynamic Asset Pricing Theory , 1992 .

[44]  C. Sin.  Complications with stochastic volatility models , 1998, Advances in Applied Probability.

[45]  Burton Hollifield,et al.  An Examination of Heterogeneous Beliefs with a Short Sale Constraint , 2002 .