Asset price bubbles, market liquidity, and systemic risk

• Published in: Mathematics and financial economics Vol. 15; no. 1; pp. 5 - 40
• Main Authors: Jarrow, Robert, Lamichhane, Sujan
• Format: Journal Article
• Language: English
• Published: Berlin/Heidelberg Springer Berlin Heidelberg 01.01.2021; Springer Nature B.V
• Subjects: Applications of Mathematics; Asset allocation; Assets; Borrowing; Collateral; Constraint modelling; Consumption; Economic conditions; Economic models; Economic Theory/Quantitative Economics/Mathematical Methods; Economics; Equilibrium; Expected utility; Finance; Great Recession; Households; Housing prices; Insurance; Liquidity; Macroeconomics/Monetary Economics//Financial Economics; Management; Markets; Mathematics; Mathematics and Statistics; Quantitative Finance; Risk; Statistics for Business; Trading; Wealth; Bubbles; E44; Asset price equilibrium; Market liquidity; G12; E58; Systemic risk; Heterogeneous agents/beliefs; Borrowing/trading constraints
• ISSN: 1862-9679; 1862-9660
• DOI: 10.1007/s11579-019-00247-9

This paper studies an equilibrium model with heterogeneous agents, asset price bubbles, and trading constraints. Market liquidity is modeled as a stochastic quantity impact from trading on the price. Bubbles are larger in liquid markets and when trading constraints are more binding. Systemic risk is defined as an unanticipated shock that results in the nonexistence of an equilibrium in the economy. A realization of systemic risk results in a significant loss of wealth. Systemic risk increases as: (i) the fraction of agents seeing an asset price bubble increases, (ii) as the market becomes more illiquid, and (iii) as trading constraints are relaxed.