Abstract

An (A) expected (strong) bubble is said to exist if it is mutual knowledge that the price of the asset is higher than the expected (possible) dividend. By requiring common knowledge instead of mutual knowledge, the new concept of common expected bubble (common strong bubble) is developed. In a simple …nite horizon model with asymmetric information and short sale constraints, which follows Allen, Morris and Postlewaite (1993), it is showed that two results hold true for any …nite number of agents: First, common strong bubbles never exist in any rational expectations equilibrium; Second, it is possible to have a bubble, which is both a strong bubble and a common expected bubble, in a rational expectations equilibrium, even with common knowledge of trades. Furthermore, the …rst result crucially depends on the implicit assumption of perfect memory, hence an example of common strong bubbles can be constructed in case that agents are forgetful. Based on these results, this paper, as well as Conlon (2004), provides a partial answer to what properties rational bubbles can have and cannot have in a rational expectations equilibrium.

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