Events

Authors:

• Kathy YUAN
  University of Michigan

• Emre OZDENOREN
  University of Michigan

Most famous asset market bubbles are associated with either a new technological innovation (electronics in the 1960s, biotechnology in the 1980 and the internet in the late 1990s) or a new investment opportunity (such as the potential trades with South America in the South Sea bubble). To capture this observation, we provide a model of the fundamental-determined asset market bubble. When the asset value is not common knowledge, which is plausible for new innovations or investment opportunities, and when firms have to rely on external asset market to finance research and developments, there exists strategic complementarity among informed investors who would invest when more informed investors invest. Assets may be over-valued as a result. We demonstrate there exists a unique equilibrium when informed investors receive noisy signals about the fundamentals and provide comparative statics analysis. Although the unique equilibrium is determined by the fundamentals, the asset price depend on financial variables, such as the quantity of hot money in circulation and the liquidity of the asset market, which may far exceed the fundamental value. The crash of the asset market bubble naturally follows from the resolution of uncertainty.