Rational Equity Bubbles

People use to believe that no bubble can exist in an infinite-horizon model with a finite number of rational individuals. However, the opinion is true only for the baseline case. In the baseline model, wealth merely provides consumption flows, which individuals only care about. No one likes to hold an asset, whose price is above its fundamental value, forever. Sooner or later, individuals will sell out the asset for the purpose of material rewards. It is the behavior that rules bubbles out. Conditions that restrict the behavior, however, can help cause a bubble in an infinite-horizon model. The constraint on debt accumulation (or, noPonzi-game condition) is one of them, as argued by Kocherlakota (1992). Furthermore, Kocherlakota (2009) shows that the credit constraint naturally leads to a bubble in the pricing of the collateral. The reason is simple. An asset that works as collateral helps to relax credit constraints. Individuals facing credit constraints have incentives to hold the asset forever, regardless of a bubble in its pricing. These constraints make bubbles not to be ruled out from an infinite-horizon model. A bubble modeled by this