Rational Exuberance and Bubbles

We study a model of dynamic adverse selection in which a large group of sellers sell an asset of uncertain quality to a larger group of buyers. The quality is known to the sellers but unknown to the buyers. There is, however, the possibility that if the asset is of low quality, this will be revealed via public news at a random time. We show that there is a unique equilibrium satisfying forward induction. In this equilibrium a bubble develops. Even a worthless asset is traded at rapidly increasing prices. This is because in the absence of bad news, buyers become more and more optimisticó they exhibit rational exuberance