Study Of An Agent In The Formation Of Asset Price Bubbles

Financial instability can have large adverse effects on an economy. One major cause of instability is asset price bubbles. Once the bubbles expand to certain scale, they will collapse, which will induce the bubble economy. Infection and the frangibility of the financial system will enlarge the small wave to a huge extend.Nowadays, agency plays an important role in the financial system. Many of the agents buying real estate, stocks, and other assets do so with other people's money. If the investment is successful, the borrower repays the loan and retains the difference between the value of the asset and the principal and interest. Otherwise, the borrower has limited liability and the lender bears the shortfall. The agency problem is excessive risk taking associated with limited liability.In the asset pricing model, the price of risky asset in a market with agencies is higher than that in a market without agencies. The more risky the asset is, the bigger the gap between the value of the asset in a agency market and the principle one will be. As the gap is defined as bubble in the asset pricing model, the more risky the asset is, the bigger the asset price bubble will be. Thus, the agency problem owing to the separation of wealth owner and investor will cause the asset price bubbles. If the bubbles boom to a certain large extend, the agency problem will cause the bubble economy and the real economy will get adverse effect.Based on the theory, this paper analyzes the stock market and real estate market of China respectively. Bubbles are found in the stock market after mid 2006, and at the same time, the scale of agency like mutual fund is expanding. Analysis is done from the perspectives of the agency itself and the finance constitution to find the incentives. On the other hand, bubbles are existing in our real estate market, especially in Shanghai. The highly debt financed investment cause the 'credit leverage promoted bubbles'. Suggestions are giver in the end to prevent bubble economy in the agency problem perspective.