Patrick Bolton, Barbara and David Zalaznick Professor of Business and Professor of Economics at Columbia University, and Sandy Grossman, Chairman and Chief Executive Officer, QFS Asset Management, discuss Jose Scheinkman's presentation at the Third Annual Kenneth Arrow Lecture. Joseph Stiglitz and Kenneth Arrow also make remarks.
Abstract of Jose Scheinkman's presentation:
Asset price bubbles are episodes in which asset prices exceed fundamentals. Three
stylized facts concerning bubbles are:
1. Asset-price bubbles are accompanied by increases in trading activity.
2. Bubble implosions coincide with increases in an asset's supply.
3. Bubbles often occur with the arrival of “new technologies"
In this lecture, I will rely on these stylized facts to argue in favor of particular models that
explain asset-price bubbles. I will start by sketching a model where speculators
overconfidence is a source of heterogeneous beliefs and arbitrage is limited, that is able
to reproduce the observed correlation between trading activity and asset prices. I will
argue that, in the presence of limited risk absorption, this same class of models can
explain the coincidence between bubble deflation and increases in asset supply or
This class of models also implies that during speculative episodes short-term-horizon
stock holders would opt for compensation contracts for man-agers that emphasize shortterm
stock performance, at the expense of long run fundamental value, as an incentive to
induce managers to pursue actions which increase the speculative component in the stock
price. As a result, bubbles would be accompanied by an increase in earnings
manipulation and in investments that impact short-term stock performance.
These models of bubbles require heterogeneous beliefs and the presence of (some)
optimism. Optimistic beliefs may be the result of simple extrapolative schemes, imitation,
or even mere randomness, but also result from the actions of interested “experts." Experts
that wish to signal their familiarity with “new technologies" have a tendency to
exaggerate their value and in this way generate over optimism among naive investors.
This explains the coincidence between the arrival of new technologies and bubbles.
In the last part of the lecture I will analyze aspects of the recent credit bubble. I will show
that the heterogeneous-beliefs-plus-limited-arbitrage view of bubbles argues against
restrictions on short-sales and for limitations on leverage. I will also contend that
measures to increase shareholder power, which have been proposed as a remedy to
excessive risk-taking by financial institutions, are unlikely to be effective unless they
simultaneously tip the balance of power towards long-term shareholders.
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