The simplest rational greater-fool bubble model

Rational bubbles and middlemen

“…Another interesting issue is the relationship between market opaqueness and robustness—in models of bubbles where the motivation of trade is risk‐sharing (Allen, Morris, and Postlewaite (1993), Liu and Conlon (2018)) or intertemporal consumption‐smoothing (Liu, White, and Conlon (2020)), would equilibrium be robust when prices are not observable? We leave them for future research.…”

“…Allen, Morris, and Postlewaite (1993) construct a model of bubbles with information asymmetry, relaxing the common‐knowledge assumption. This line of models is often referred to the “greater fool theory” approach and substantially simplified in a sequence of papers by Conlon (2004, 2015), Liu and Conlon (2018) and Liu, White, and Conlon (2020). These papers and the current paper both point the crucial role of higher‐order uncertainty in the occurrence of bubbles.…”

“…Other existing models in this literature emphasize risk-sharing(Allen, Morris, and Postlewaite (1993),Liu and Conlon (2018)) or intertemporal consumption-smoothing(Liu, White, and Conlon (2020)) as the motive for trade. In contrast, the motive for trade in our model is neither risk-sharing nor consumptionsmoothing, but is based on middlemen's incentive to flipping.6 In a timing game model of bubble, Doblas-Madrid (2012) also generates a bubble in which a price increases, and his model, gains from trade are rooted in a liquidity shock.…”

“…44 See, for example, Conlon (2015) and Liu and Conlon (2018) for a discussion of this matter. They argue that with a continuum of states, the bubble equilibrium is robust. …”

“…55 Other existing models in this literature emphasize risk‐sharing (Allen, Morris, and Postlewaite (1993), Liu and Conlon (2018)) or intertemporal consumption‐smoothing (Liu, White, and Conlon (2020)) as the motive for trade. In contrast, the motive for trade in our model is neither risk‐sharing nor consumption‐smoothing, but is based on middlemen's incentive to flipping. …”