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Rational bubbles and the spirit of capitalism

Zhou, Ge (2011): Rational bubbles and the spirit of capitalism.

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Abstract

This paper explores the existence of rational bubbles in the pricing of an asset that pays no dividend. I find that when "the spirit of capitalism" is introduced into a growth model, rational bubbles do exist provided that the marginal benefit from holding wealth is nontrivial relative to the marginal utility of consumption as time goes to infinity. I use phase diagrams to discuss the property of the bubbly equilibrium and I use two examples to describe the bubbly equilibrium trajectory explicitly and more intuitively. Moreover, I show that a stochastic bubble, which bursts with an exogenous probability, could exist. This could provide a simple theoretical foundation to explore economic implications of the collapse of bubbles.

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