The Martingale Theory of Bubbles: Implications for the Valuation of Derivatives and Detecting Bubbles

After the 2007–9 credit crisis, caused by a crash in housing prices (the bursting of an alleged housing price bubble), asset price bubbles received considerable attention in the financial press and regulatory arena.11 See William Dudley, “Asset Bubbles and the Implications for Central Bank Policy”, speech, April 7, 2010 (available at http://www.ny.frb.org). Before this episode, however, the modelling of asset price bubbles had a long history in economics.

Classical economics studied the existe

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