Asset Bubbles and Credit Constraints
American Economic Review · 2018 · Volume 108 · Issue 9
Abstract
We provide a theory of rational stock price bubbles in production economies with infinitely lived agents. Firms meet stochastic investment opportunities and face endogenous credit constraints. They are not fully committed to repaying debt. Credit constraints are derived from incentive constraints in optimal contracts which ensure default never occurs in equilibrium. Stock price bubbles can emerge through a positive feedback loop mechanism and cannot be ruled out by transversality conditions. These bubbles command a liquidity premium and raise investment by raising the debt limit. Their collapse leads to a recession and a stock market crash.
Keywords
Intertemporal Firm Choice: Investment, Capacity, and Financing, Investment, Capital, Intangible Capital, Business Fluctuations, Cycles, Financial Markets and the Macroeconomy, Asset Pricing, Trading Volume, Bond Interest Rates, Information and Market Efficiency, Event Studies, Insider Trading
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