Transaction Services and Asset-Price Bubbles

This paper examines asset-price bubbles in an economy where a nondepletable asset (e.g., land) can provide transaction services, using a variant of the cash-in-advance model. When a landowner can borrow money immediately using land as collateral, one can say that land essentially provides a transaction service. The transaction services that such an asset can provide increase as its price rises, since the asset owner can borrow more money against the asset's increased value. Thus an asset-price bubble can emerge due to the externality of self-reference wherein the asset price reflects the transaction services that it can provide, while the amount of the transaction services reflects the asset price. If the collateral ratio of the asset (θ) is not too high, there exists a steady state equilibrium where the asset price has a bubble component; if θ exceeds a certain value, there exists no stable equilibrium. The paper also analyzes the case where θ is determined as an equilibrium outcome. Finally, in the case where the equilibrium concept is relaxed to allow for sticky prices and a temporary supply-demand gap, the paper shows that there exists an equilibrium where a bubble develops temporarily and eventually bursts.