Bubbles, collateral and monetary equilibrium

Abstract

Consider an economy where infinite-lived agents trade assets collateralized by durable goods. We obtain results that rule out bubbles when the additional endowments of durable goods are uniformly bounded away from zero, regardless of whether the asset’s net supply is positive or zero. However, bubbles may occur, even for state-price processes that generate finite present value of aggregate wealth. First, under complete markets, if the net supply is being endogenously reduced to zero as a result of collateral repossession. Secondly, under incomplete markets, for a persistent positive net supply, under the general conditions guaranteeing existence of equilibrium. Examples of monetary equilibria are provided.