Toxic asset bubbles

We develop an overlapping generations model with leveraged investment in speculative asset bubbles. Financial intermediaries use borrowed funds to speculate on a risky asset bubble, which promises high returns as long as it does not collapse. They can, however, default on their debt and shift the losses to lenders when the bubble collapses. This risk shifting leads to welfare-reducing (or "toxic") rational asset bubbles. We then analyze a set of often discussed policy interventions: pricking bubbles, macroprudential regulations, and leverage restriction.