[UTMD-114] Bubbles and Collateral (by Yu Awaya, Jihwan Do, Makoto Watanabe)

Yu Awaya, Jihwan Do, Makoto Watanabe

We construct a model of bubbles where an asset can be used as collateral primarily due to higher-order uncertainty: while both a lender and a borrower know that the intrinsic value of the asset is low, they may still believe that a “greater fool” exists who will purchase it at a much higher price. In environments where agents suffer hold-up problems, we show that such bubbles can raise investment and, under certain conditions, lead to inefficient overinvestment, even when all agents know that the asset’s intrinsic value is low or even zero. Using this framework, we also examine the impacts of macroprudential policies, as well as other regulatory measures such as interest rate hikes and the resolution of uncertainty.