Abstract
We maintain that a speculative bubble exists if the market price of an asset differs from its fundamental value—the expected present value of the stream of future dividends attached to the asset. In an economy with a finite sequence of trading dates, the fundamental theorem of asset pricing (see Dybvig and Ross, 1987) guarantees that the equilibrium market price of any asset equals its fundamental value. But in some economies with an infinite sequence of trading dates, this result does not hold, and speculative bubbles may arise. An investor might buy an asset at a price higher than its fundamental value if she expects to sell it later on at a higher price—Harrison and Kreps (1978) call this process ‘speculative behaviour’. In general equilibrium models, however, agents take prices as given and trade assets to transfer income across time and states. These models do not contemplate ‘speculative behaviour’ as it is usually understood. Therefore, the term ‘speculative bubble’ may seem inappropriate in some theoretical frameworks. Santos and Woodford (1997) talk broadly about ‘asset pricing bubbles’.