Asset Price Bubbles, Market Liquidity and Systemic Risk

48 Pages Posted: 1 Mar 2018 Last revised: 1 Sep 2019

See all articles by Robert A. Jarrow

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management

Sujan Lamichhane

International Monetary Fund (IMF)

Date Written: August 25, 2019

Abstract

This paper studies an equilibrium model with heterogeneous agents, asset price bubbles, and trading constraints. Market liquidity is modeled as a stochastic quantity impact from trading on the price. Bubbles are larger in liquid markets and when trading constraints are more binding. Systemic risk is defined as an unanticipated shock that results in the nonexistence of an equilibrium in the economy. A realization of systemic risk results in a significant loss of wealth. Systemic risk increases as: (i) the fraction of agents seeing an asset price bubble increases, (ii) as the market becomes more illiquid, and (iii) as trading constraints are relaxed.

Keywords: asset price equilibrium, bubbles, market liquidity, systemic risk,heterogeneous agents/beliefs, borrowing/trading constraints

JEL Classification: G12, E44, E58

Suggested Citation

Jarrow, Robert A. and Lamichhane, Sujan, Asset Price Bubbles, Market Liquidity and Systemic Risk (August 25, 2019). Available at SSRN: https://ssrn.com/abstract=3126840 or http://dx.doi.org/10.2139/ssrn.3126840

Robert A. Jarrow (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Department of Finance
Ithaca, NY 14853
United States
607-255-4729 (Phone)
607-254-4590 (Fax)

Sujan Lamichhane

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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