Return-Preserving Bubbles

Abstract

This paper introduces a bubbly asset to a standard macroeconomic model with heterogeneous agents and borrowing constraints. In this tractable quantitative framework, I show the possibility of a return-preserving bubble that absorbs savings with no good investment opportunities. Analysis of the stationary benchmark shows that the equilibrium could be unique, and that low economic growth propagates bubbles. Further exploration of the cyclicality in the bubbly asset shows that its returns are procyclical and it has a low expected rate of return that equals the expected economic growth rate. These cyclical properties are consistent with puzzling empirical results on gold.