FINITE BUBBLES WITH SHORT SALE CONSTRAINTS AND ASYMMETRIC INFORMATION

We present a finite period general equilibrium model of an exchange economy with asymmetric information. We say that a rational expectations equilibrium exhibits a strong bubble if the price is higher than the dividend with probability one. We show that necessary conditions for a strong bubble to occur are that (1) each agent must have private information in the period and state in which the bubble occurs, (2) each agent must be short sale constrained at some period in the future with positive probability, and (3) agents’ trades are not common knowledge. We present examples of bubbles when the necessary conditions are satisfied. Journal of Economic Literature Classification Numbers: C72, D52, D82, D84, G12, G14. © 1993 by Academic Press, Inc.