Overconfidence and Speculative Bubbles Jose A Scheinkman;Wei Xiong The Journal of Political Economy:Dec 2003;111,6;ABI/INFORM Global Pg1183 Overconfidence and Speculative Bubbles Jose A.Scheinkman and Wei Xiong Princeton University Motivated by the behavior of asset prices,trading volume,and price volatility during episodes of asset price bubbles,we present a contin- uous-time equilibrium model in which overconfidence generates dis- agreements among agents regarding asset fundamentals.With short- sale constraints,an asset buyer acquires an option to sell the asset to other agents when those agents have more optimistic beliefs.As in a paper by Harrison and Kreps,agents pay prices that exceed their own valuation of future dividends because they believe that in the future they will find a buyer willing to pay even more.This causes a significant bubble component in asset prices even when small differences of beliefs are sufficient to generate a trade.In equilibrium,bubbles are accompanied by large trading volume and high price volatility.Our analysis shows that while Tobin's tax can substantially reduce specu- lative trading when transaction costs arc small,it has only a limited impact on the size of the bubble or on price volatility. I. Introduction The behavior of market prices and trading volumes of assets during historical episodes of price bubbles presents a challenge to asset pricing theories.A common feature of these episodes,including the recent This paper was previously circulated under the title"Overconfidence,Short-Sale Con- straints and Bubbles."Scheinkman's research was supported by the Chaire Blaise Pascal and the National Science Foundation,and partially done while he was visiting the Uni- versite Paris-Dauphine.We would like to thank Patrick Bolton,Markus Brunnermeier, John Cochrane,George Constantinides,Darrell Duffie,Ivar Ekeland,Edward Glaeser,Ravi Jagannathan,Pete Kyle.Owen Lamont,Marcelo Pinheiro,Chris Rogers,Tano Santos, Walter Schachermayer,Harald Uhlig,Dimitri Vayanos,two anonymous referces,and sem- inar participants at various institutions and conferences for comments. gC28Anlwmy2/1IwoinSioe时 1183 Reproduced with permission of the copyright owner.Further reproduction prohibited without permission.Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Overconfidence and Speculative Bubbles Jose A Scheinkman; Wei Xiong The Journal of Political Economy; Dec 2003; 111, 6; ABI/INFORM Global pg. 1183