The rapid increase in home prices over the past several years has raised concerns about the existence of a speculative bubble in this asset market. A closely related concern—irrespective of any existing bubble—is whether home prices are susceptible to a steep decline that could have a severe impact on the broader economy. Indeed, home prices have been rising rapidly. Since 1995, real home price...

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 ...

Motivated by the behavior of asset prices, trading volume and price volatility during historical episodes of asset price bubbles, we present a continuous time equilibrium model where overconfidence generates disagreements among agents regarding asset fundamentals. With short-sale constraints, an asset owner has an option to sell the asset to other overconfident agents when they have more optimi...

Harrison and Kreps showed in 1978 how the heterogeneity of investor beliefs can drive speculation, leading the price of an asset to exceed its intrinsic value. By focusing on an extremely simple market model – a finite-state Markov chain – the analysis of Harrison and Kreps achieved great clarity but limited realism. Here we achieve similar clarity with greater realism, by considering an asset ...

Should central banks respond to asset price bubbles? This paper explores this monetary policy question in a hypothetical economy subject to asset price bubbles. Despite the highly stylized structure of the model, the results reveal several practical monetary policy lessons. First, a monetary authority should generally respond to asset prices as long as asset prices contain reliable information ...

Asset market experiments are analyzed by distinguishing, ex post facto, participants who trade on fundamentals versus those who trade on momentum (i.e., buying when price is rising). The distinction is made when prices are above fundamental value, so that (in each period) those who have more offers than bids (net offerers) are classified as fundamentalists while those who have more bids than of...