3 ORIGIN OF ASSET PRICE BUBBLES
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let agents coordinate into one equilibrium and it could also explain how booms and busts of asset prices can happen in equilibrium. That is, one can apply the sunny and cloudy sky metaphor to periods with generalized optimistic and pessimistic views about the future prospects of, for example, a particular company or the housing sector in a country. In this chapter, we have considered a very simple model of rational bubbles. For the interested reader, Tirole (1985) is the seminal paper of modern rational bubbles. He considers an overlapping generation model with capital accumulation. Another relevant reference is Santos and Woodford (1997). They identify general conditions under which rational bubbles can emerge in equilibrium. Finally, Martin and Ventura (2017) summarizes and explains the new generation of rational bubbles, which emphasize borrowing constraints.
3.3 A Model of Rational Housing Bubbles In this section, we apply the theory of rational bubbles to the particular case of housing bubbles. Since it is a model of rational bubbles, the reason why bubbles can emerge in equilibrium is that there will be a shortage of assets. In particular, the shortage of asset will arise because agents will be financially constrained. A large number of papers have shown how financial constraints can be conducive to rational bubbles. This list includes, among others, Woodford (1990), Caballero et al. (2006), Arce and Lopez-Salido (2011), Farhi and Tirole (2012), and Martin and Ventura (2012). The discussion in this chapter will be based on Basco (2014), which specifically incorporates housing into the model.4 The key elements of the model will be that agents derive utility from housing services and that the financial constraint depends on both the quality of financial institutions and the value of housing.5 4 Arce and Lopez-Salido (2011) also develop a rational housing bubble. They consider an economy where agents face heterogenous financial constraints and have the option to purchase or rent the house. We explain Basco (2014) because, in addition to the closed economy equilibrium, he investigates the effect of globalization on the emergence of housing bubbles, which will be the main topic of the next chapter. 5 In this book, we focus on housing bubbles. There exists a large literature that develops quantitative macroeconomic models to understand the effects (and causes) of housing booms. A recent important contribution is Favilukis et al. (2017), who emphasize financial liberalization as the driver of the recent US housing boom. The reader is referred to this paper and references within for further details.
