Liquidity based modeling of asset price bubbles via random matching

TL;DR

This paper develops a stochastic liquidity-based model for asset price bubbles, incorporating contagion effects among investors through random matching, and provides conditions for arbitrage-free markets along with numerical simulations.

Contribution

It extends existing liquidity-based models by including stochastic exogenous factors and a directed random matching mechanism, offering a more realistic depiction of bubble dynamics.

Findings

Model is arbitrage-free under certain conditions

Numerical simulations illustrate contagion-driven bubble evolution

Extension of Markov matching to stochastic settings

Abstract

In this paper we study the evolution of asset price bubbles driven by contagion effects spreading among investors via a random matching mechanism in a discrete-time version of the liquidity based model of [25]. To this scope, we extend the Markov conditionally independent dynamic directed random matching of [13] to a stochastic setting to include stochastic exogenous factors in the model. We derive conditions guaranteeing that the financial market model is arbitrage-free and present some numerical simulation illustrating our approach.