Rational bubbles and middlemen

Abstract

This paper develops a model of rational bubbles where trade of an asset takes place through a chain of middlemen. We show that there exists a unique and robust equilibrium, and a bubble can occur due to information frictions in bilateral and decentralized markets. Under reasonable assumptions, the equilibrium price is increasing and accelerating during bubbles although the fundamental value is constant over time. Bubbles may be detrimental to the economy, but any announcement from the central bank has no effect on welfare with risk neutral agents. Middlemen are the source of financial fragility.

A Three‐state Rational Greater‐fool Bubble Model With Intertemporal Consumption Smoothing

“…Note the similarity to results inAwaya et al (2022), where a bubble-bursting announcement rule prevents trade in states where bubble-bursting announcements are made, since the bubble asset is no longer available to trade with, but where the presence of that rule improves trade in states where bubble-bursting announcements are not made. This sort of result may therefore begin to rise to the level of "conventional wisdom" in greater-fool bubble models.30 In general, the policy does not always hurt Frank in state L, nor does it always benefit him in state H. For example, if we change Frank's period-1 endowment e F 1 (L, H ) from 3 to 10, then the bubble and the policy equilibria would stay the same.…”

“…Ellen's lifetime welfare therefore rises and Frank's falls in that state. 24 The asset-deflation policy we discuss here-simply announcing whether states b or L occurred-thus resembles the policies in Asako and Ueda (2014), Conlon (2015), Holt (2018), andAwaya et al (2022). However, it is not the only sort of anti-bubble policy a central bank might pursue.…”

“…Specifically, borrowers' investments may pay off more than lenders' investments, so lenders are willing to take the chance of lending to those borrowers, in hopes of getting high returns. Similarly, Awaya et al (2022) assume a sequence of middlemen who cannot, themselves, use the asset, but instead sell it on to a final buyer to whom the asset may be valuable.…”

Is Money Essential? An Experimental Approach

“…Indeed, it is incomplete knowledge of the timing that allows fiat currency to be valued, and that is what allows an improvement on autarky. 8 While this baseline model serves our purposes nicely in the lab, there is an extension that is interesting for its own sake, and especially relevant in light of the experimental results discussed below. Although in theory Model M has players unable to distinguish between the first and second meetings, if the game proceeds in real time, inferences may be possible based on how long it takes to meet a potential trading 8 A referee suggests that money here operates through "obfuscation."…”

“…8 While this baseline model serves our purposes nicely in the lab, there is an extension that is interesting for its own sake, and especially relevant in light of the experimental results discussed below. Although in theory Model M has players unable to distinguish between the first and second meetings, if the game proceeds in real time, inferences may be possible based on how long it takes to meet a potential trading 8 A referee suggests that money here operates through "obfuscation." In Model M with money, if your trading partner has money, you don't know if you are Player 2 or 3, so you might produce.…”