Friday, February 10, 2012

Asset Price Bubbles: A Survey by Anna Scherbina, Bernd Schlusche :: SSRN

A bubble.Image via Wikipedia
Asset Price Bubbles: A Survey by Anna Scherbina, Bernd Schlusche :: SSRN

In class next week we will be talking about bubbles. No not this one, nor even this one, but financial bubbles. Financial bubbles have a long history going back decades. A few examples: the famous Dutch Tulip Bubble, the South Sea Bubble (1720)--BTW WATCH THIS short video on it, VERY GOOD!),the late 1920s US stock market , the Japanese bubble of late 1980s, the Internet Bubble of 1998-2000 (here is a video from that time by CNN that is very telling), and of course the most recent real estate bubble.

One of the papers we will be examining is this by Scherbina and Schlusche:

"The persistent failure of present-value models to explain asset price levels led academic research to introduce the concept of bubbles as a tool to model price deviations from present-value relations. The early literature was dominated by models in which all agents were assumed to be rational and yet a bubble could exist. In many of the more recent papers, the perfect rationality assumption was relaxed, allowing the models to shift the focus to explaining how a bubble may be initiated, under which conditions it would burst, and why arbitrage forces may fail to ensure that prices reflect fundamentals at all times. In light of the recent U.S. real estate bubble, the question of why bubbles are so prevalent is once again a matter of concern of academics and policy makers. This paper surveys the recent literature on asset price bubbles, with significant attention given to behavioral models as well as rational models with incentive problems, market frictions, and non-traditional preferences"

I should add, that these are not all agreed upon as bubbles. Some explain the high volatility merely using high levels of volatility and a real option analysis. This definitely is a source of some price run-ups, but I have a hard time convincing myself that it explains a large portion of the price changes.
Enhanced by Zemanta

1 comment:

alternative investments said...

I am a Brit living temporarily in the States, and should add that I am certainly not an academic expert when it comes to finance. However, in regards to asset bubbles, I think one of the big mistakes by central bankers (esp. Greenspan and the FED) was to not realize the negative affect asset bubbles could have on an economy. First, it seems like asset bubbles promote malinvestment - the housing booms in the US and UK being Exhibits A & B. At least could argue that the internet bubble of the late 90s left behind much useful infrastructure, especially in the area of fiber optic capacity around the world, but it seems that housing was a kind of madness that did not add to the overall competitiveness in the economy (I'd add that there has long been an "asset bubble" in employment in the finance sector with the best and the brightest going to the City or Wall Street to trade paper, but suppose thats a personal prejudice).

Second, the central banks did not consider what would happen when asset bubbles popped. One could easily argue that the last two recessions have been caused largely by the popping of asset bubbles.

This all leads to the conclusion that perhaps (again, not an academic here!) central bankers need to consider slowly letting the air out of asset bubbles before they get out of control, although it seems like Greenspan never saw that as his responsibility.