Rational Finite Bubbles
NBER Working Paper No. 3707
There has been a long-running debate about whether stock market prices are determined by fundamentals. To date no consensus has been reached. An important issue in this debate concerns the circumstances in which deviations from fundamentals are consistent with rational behavior. A continuous-time example where there are a finite number of rational traders with finite wealth is presented. it is shown that a finitely-lived security can trade above its fundamental.
Published: Allen, Franklin and Gary Gorton. Churning Bubbles." Review of Economic Studies 60, 4 no. 205 (October 1993): 813-836.