The Boy Who Cried Bubble : Public Warnings against Riding Bubbles

Attempts by governments to stop bubbles by issuing warnings seem unsuccessful. This paper examines the effects of public warnings using a simple model of riding bubbles. We show that public warnings against a bubble can stop it, if investors believe that a warning is issued in a definite range of periods around the bubble starting time. Moreover, the bubble may crash before the warning. If a warning involves the possibility of being issued too early regardless of the bubble starting time, then it cannot stop the bubble immediately. The bubble duration can be shortened by a public warning issued early accidentally, but lengthened if it is issued late accidentally. Our model suggests that governments need to lower the probability of spurious warnings