Are the liquidity and collateral roles of asset bubbles different?

Abstract

Several recent papers introduce dierent mechanisms to explain why asset bubbles are observed in periods of larger growth. These papers share common assumptions, heterogeneity among traders and credit market imperfection, but dier in the role of the bubble, used to provide liquidities or as collateral in a borrowing constraint. In this paper, we introduce heterogeneous traders by considering an overlapping generations model with households living three periods. Young households cannot invest in capital, while adults have access to investment and face a borrowing constraint. We compare the liquidity and collateral roles of bubbles to enhance growth. When the bubble is deterministic, the equilibrium is identical under these two roles. This means that the same mechanism explains the crowding-in eect of the bubble on growth. We further show that a bubble with a crowding-in eect on growth also enhances welfare. When the bubble is stochastic, i.e. may burst with a positive probability, the liquidity and collateral roles of the bubble are no more identical. With stochastic bubbles, growth is larger when bubbles play the liquidity role, because the burst of a bubble used for liquidity is less damaging to agents who invest in capital.