This article reviews the theory of speculative bubbles. Bubbles are a promising candidate as an explanation for the stock price run-up and collapse of the 1990s in the United States. The theory considers both irrational and rational bubbles, with emphasis on the latter. Rational bubbles, defined as the excess of security or portfolio prices over present values, can occur under conditions that are well understood. One argument relies on the assumed Pareto-optimality of equilibrium that rules out rational bubbles, but it is suggested that this argument is implausible.
In Market Efficiency: Stock Market Behaviour in Theory and Practice, Andrew W. Lo has collected the major papers, both theoretical and empirical, that have defined the development of the theory of efficient capital markets. The first volume has an introduction by the editor and a foreword by Richard Roll. Both are brief—too brief, in my opinion—but excellent. The papers are grouped into five parts. In Volume I, Part I is “Theoretical Foundations.” The included articles are by Black (1986), Fama (1970), Grossman (1976), Grossman and Stiglitz (1980), LeRoy (1973), Lucas (1978), and Samuelson (1965). Part II is “The Random Walk Hypothesis.” The articles are by Cootner (1962), Cowles and Jones (1937), Fama (1965), Fama and Blume (1966), Fama and French (1988), French and Roll (1986), Jegadeesh (1990), Kim, Nelson, and Startz (1991), Lo (1991), Lo and MacKinlay (1988), Osborne (1959), Porterba and Summers (1988), and Richardson (1993). In Volume II, Part I is “Variance Bounds Tests.” Included articles are by Campbell and Shiller (1989), Flavin (1983), Gilles and LeRoy (1991), Grossman and Shiller (1981), Kleidon (1986), LeRoy and Porter (1981), Marsh and Merton (1986), Merton (1987), Michener (1982), Shiller (1981), and West (1988).
Mortgage originators offer borrowers various combinations of “points”—loan fees—and coupon: high points and low coupon or low points and high coupon. In this article points are interpreted as a device serving to separate borrowers with high prepayment probabilities from those with low prepayment probabilities. Borrowers and lenders are treated symmetrically: both are risk neutral and both have complete and frictionless access to credit markets (implying that borrowers can finance points if they wish), except that borrowers’ prepayment speeds are private knowledge. Equilibria are derived, both when borrowers cannot prepay voluntarily and when they can.
[Mortgage originators offer borrowers various combinations of "points"--loan fees--and coupon: high points and low coupon or low points and high coupon. In this article points are interpreted as a device serving to separate borrowers with high prepayment probabilities from those with low prepayment probabilities. Borrowers and lenders are treated symmetrically: both are risk neutral and both have complete and frictionless access to credit markets (implying that borrowers can finance points if they wish), except that borrowers' prepayment speeds are private knowledge. Equilibria are derived, both when borrowers cannot prepay voluntarily and when they can.]
Journal Article Stock Market Optimality: Comment Get access Stephen F. LeRoy Stephen F. LeRoy Federal Reserve Board Search for other works by this author on: Oxford Academic Google Scholar The Quarterly Journal of Economics, Volume 90, Issue 1, February 1976, Pages 150–155, https://doi.org/10.2307/1886091 Published: 01 February 1976
It has now been a decade since the first of the variance-bounds papers was circulated in typescript. If initially less interest was displayed in this material than the authors had hoped and expected, the same is no longer true. This may be a good time to discuss a few of the many recent papers extending and criticizing the original results. The central idea underlying the variancebounds tests is very simple. Consider stock prices. The perfect foresight price of stock -that price which would prevail if future dividends xt+i were known-is
This paper identifies restrictions on preferences under which various classes of “expectations” theories of asset prices—i.e., uncertainty models of asset prices which coincide with the corresponding certainty theory except that expected future prices replace actual future prices—are valid. Major classes of expectations models surveyed are martingale models, the expectations hypothesis of the term structure of interest rates, and models of exhaustible resources and futures markets. In each case the required restriction is related to the assumptiono f risk—neutrality, but the precise nature of the required restriction is shown to differ significantly among the various classes of expectations theories.
This paper identifies restrictions on preferences under which various classes of “expectations” theories of asset prices—i.e., uncertainty models of asset prices which coincide with the corresponding certainty theory except that expected future prices replace actual future prices—are valid. Major classes of expectations models surveyed are martingale models, the expectations hypothesis of the term structure of interest rates, and models of exhaustible resources and futures markets. In each case the required restriction is related to the assumptiono f risk—neutrality, but the precise nature of the required restriction is shown to differ significantly among the various classes of expectations theories.