Working Paper: NBER ID: w2821
Authors: Philippe Weil
Abstract: It is often argued that a rational bubble, because it is positive, must increase the price of a stock. This argument is not valid in general: as soon as bubbles affect interest rates, the fundamental value of a stock depends on whether or not a bubble is present. The existence of a rational bubble then might, by raising equilibrium interest rates, depress the fundamental to such an extent that the sum of the positive bubble and decreased fundamental falls short of the fundamental, no-bubble price. Under conditions made precise below, there can therefore be price decreasing bubbles, and an asset can be "undervalued."
Keywords: Rational bubbles; Asset pricing; Interest rates
JEL Codes: D53; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Existence of a rational bubble (E32) | Increased equilibrium interest rates (E43) |
| Increased equilibrium interest rates (E43) | Decreased fundamental value of the asset (G19) |
| Existence of a rational bubble (E32) | Decreased fundamental value of the asset (G19) |
| Increased equilibrium interest rates (E43) | Decreased overall price of the asset (G19) |
| Existence of a rational bubble (E32) | Decreased overall price of the asset (G19) |