To Bubble or Not to Bubble: Asset Price Dynamics and Optimality in OLG Economies

TL;DR

This paper analyzes asset price bubbles in an overlapping generations economy, identifying conditions for bubble existence, characterizing equilibrium dynamics, and linking asset prices to Pareto optimality.

Contribution

It provides a complete characterization of equilibrium sets and asset price dynamics, establishing precise conditions for bubble existence and optimality in OLG models.

Findings

Bubbles exist if interest rate is below population growth rate.

Equilibrium set characterized under stationary endowments.

Bubbles are linked to Pareto optimality conditions.

Abstract

We study an overlapping generations (OLG) exchange economy with an asset that yields dividends. First, we derive general conditions, based on exogenous parameters, that give rise to three distinct scenarios: (1) only bubbleless equilibria exist, (2) a bubbleless equilibrium coexists with a continuum of bubbly equilibria, and (3) all equilibria are bubbly. Under stationary endowments and standard assumptions, we provide a complete characterization of the equilibrium set and the associated asset price dynamics. In this setting, a bubbly equilibrium exists if and only if the interest rate in the economy without the asset is strictly lower than the population growth rate and the sum of per capita dividends is finite. Second, we establish necessary and sufficient conditions for Pareto optimality. Finally, we investigate the relationship between asset price behaviors and the optimality of equilibria.