Negative Bubbles Under Short-Sales Constraints and Heterogeneous Beliefs

31 Pages Posted: 18 Nov 2016

See all articles by Huining Henry Cao

Huining Henry Cao

Cheung Kong Graduate School of Business

Hui Ou-Yang

Cheung Kong Graduate School of Business

Dongyan Ye

Cheung Kong Graduate School of Business

Date Written: November 17, 2016

Abstract

In a dynamic trading model, investors with heterogeneous beliefs have an option to sell the stock now and buy it back later. Due to this repurchase option and the risk aversion of investors, it is possible for the stock price to be lower than the lowest valuation among investors even when the short-sales constraint is binding. This result contrasts that of Harrison and Kreps (1978) in which due to a resale option and risk neutrality, a bubble always arises. We also demonstrate that in a static model, there exists neither a bubble nor a negative bubble.

Keywords: Negative Bubbles, Short-Sales Constraints, Heterogeneous Beliefs

JEL Classification: G10, G12, G14

Suggested Citation

Cao, Huining Henry and Ou-Yang, Hui and Ye, Dongyan, Negative Bubbles Under Short-Sales Constraints and Heterogeneous Beliefs (November 17, 2016). Available at SSRN: https://ssrn.com/abstract=2871088 or http://dx.doi.org/10.2139/ssrn.2871088

Huining Henry Cao

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Hui Ou-Yang (Contact Author)

Cheung Kong Graduate School of Business ( email )

Hong Kong
China
852-5199-6227 (Phone)

Dongyan Ye

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

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