title: The emergence of asset price bubbles and debt overhang
Creators: name: Tang, Ziyu
Publisher: name: University of Glasgow
Year: 2024

description: This paper has an in-depth discussion on the correlation between asset price bubbles and monetary policy. In this paper we proposed a novel theory of asset bubbles; provided empirical evidence of our theory; provided a discussion on the correlation between debt overhang, which is a common problem for enterprises after the burst of asset bubbles, and the power structure of enterprises.

In the first chapter, we briefly introduced the historical background of asset price bubbles and the motivation of our paper. We believe that the current literature research is insufficient on how monetary policy affects asset bubbles. Since 2022 the inflation is leading to the tightening of monetary policy highlights the necessity to study the impact of monetary policy on asset price bubbles. Moreover, in the adverse scenario of asset price bubble bursts, we also need to explore how to alleviate debt overhang to promote economic recovery.

In the second chapter we provide a theory of the relation between asset price bubbles and monetary policy. With incomplete information, the uncertainty caused by stochastic technology shock leads to a bubble. Households adjust investment decisions through the case-based decision (CBD) process from the information generated by utility feedback that strengthens or weakens their beliefs. Without easing monetary policy, this information feedback process will exclude bubbles in the long-term equilibrium in which bubbles stochastically emerges. Easing monetary policy mitigates the problem of investment misallocation, and hence distorts the information feedback and enables bubbles to exist in the long-term equilibrium.

In the third chapter we analyze the effects of monetary policy on asset bubble in the US stock market over the period 1954-2019 based on ex post mispricing indicator at the firm level by using a fixed-effect panel model. The results suggest that easing (tight) monetary policy have a positive (negative) effect on the upward movement of asset mispricing.

In fourth chapter we use a structural vector autoregression (SVAR) model identified by directed acyclic graphs (DAGs) to conduct market-level analysis. In line with firm level analysis, our evidence in this chapter suggests that easing (tightening) monetary policy has a significantly positive (negative) effect on the upward movements of bubble components or asset overpricing. 

In the fifth chapter we discussed the effect of centralized decision power on the debt overhang, to discuss if the adverse consequences of asset price bubble could be mitigated through diversified power structure of companies. Following the stakeholder theory, we assume that a more diversified decision structure tends to maximum the overall interest of the firm. We developed a theory to model how a centralized management would influence the decision process of investment over debt overhang. We show that a firm with higher CEO power react more sensitive to the effect of debt overhang, which support our hypothesis. 

In the sixth chapter, we provide a summary and conclusions.