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The model has also implications for the relationship between the size of the bubble and the level of financial globalization. To see this more clearly, we can rearrange Eq. (4.12) and write the size of the bubble as B(τ ) = AU (1) − DU (1) + τ AC (1) − DC (1) . (4.13)
The first term in Eq. (4.13) is the net demand of assets of the financially developed economy when R = 1, which, as we discussed, it is negative. The second term is the net demand of assets of one financially underdeveloped country at R = 1 multiplied by the fraction of financially underdeveloped economies participating in the international capital market (τ). As we have seen above, financially underdeveloped economies have a positive net demand of assets when R = 1 (i.e., AC (1) > DC (1)). That is, the first term on the right-hand side of Eq. (4.13) is negative and the second term is positive. As financial globalization progresses (larger τ ), the weight of the second term (the positive one) increases and, thus, the right-hand side of Eq. (4.13) rises. This means that, as financial globalization progresses, it becomes more likely that a bubble emerges (i.e., B(τ ) > 0) and, if the bubble already exists, it will raise its size. Finally, as we have pointed out, the model cannot determine in which asset the bubble is going to be attached. However, if the bubble is attached to houses, the price of houses in the financially developed economy will be given by,
1 1 1+ε 1+ε > σ U (R(τ )) = pNB (τ ). (4.14) pB (τ ) = B(τ ) + σ U (R = 1)
This equation is analogous to the price of houses in a financial underdeveloped economy derived in Eq. (3.10). B(τ) is the size of the bubble, which depends on the level of financial globalization (see Eq. 4.12) and σU(R) is the fundamental demand of housing. Note that for the case of the financially developed economy, this fundamental demand depends on the interest rate. This was not the case for the financially underdeveloped economy because the housing demand was determined by the borrowing constraint (Eq. R6). The choice of housing of agents in financially developed economies is not determined by this constraint. As we discussed, housing demand depends on the user cost of housing (the first term into brackets in Eq. R5). It is easy to check (from Eq. R5) that if the interest rate falls, the user cost of housing falls and, thus, housing
