A Regime Switching Equilibrium Model for Asset Bubbles

Our model combines an equilibrium approach for asset bubbles with a Markovian regime switching environment affecting the interest rate. An asset bubble is here defined as the difference between the minimal equilibrium price... [ view full abstract ]

Our model combines an equilibrium approach for asset bubbles with a Markovian regime switching environment affecting the interest rate. An asset bubble is here defined as the difference between the minimal equilibrium price and the intrinsic value that can be computed explicitly. We consider a dividend rate given by an Ornstein-Uhlenbeck process as the only source of income from the asset. A solution of a hypergeometric matrix differential equation is constructed using matrix special functions. This can, under some restrictions, be identified as an minimal equilibrium price. As a result, a bubble can be calculated explicitly.