CFE 2015: Start Registration
View Submission - CFE
A1465
Topic: Contributed on Asset price bubbles Title: Doubts, inequality, and bubbles Authors:  In-Koo Cho - University of Illinois (United States)
Kenneth Kasa - Simon Fraser University (Canada) [presenting]
Abstract: Two agents share a common benchmark model for dividends. Each is risk-neutral but uncertainty averse, i.e., preferences are linear in consumption, but each agent has doubts about the specification of the dividend process. These doubts manifest themselves has a preference for robustness. Robust preferences introduce pessimistic drift distortions into the benchmark dividend process. These distortions increase with the level of wealth, and give rise to endogenous heterogeneous beliefs. Belief heterogeneity allows asset price bubbles to emerge. A novel implication of our analysis is that bubbles are more likely to occur when wealth inequality increases. A key advantage of our analysis is that detection error probabilities can be used to assess whether empirically plausible doubts about dividends can explain observed bubble episodes.