A MODEL OF FORMATION OF ASSET BEUBBLES

A non-stationary time series is derived to describe the process of the formation of asset bubbles. The model is based on leverage and easy credit: the root cause of all financial bubbles. The discrete version of the model is used to present the intuition behind the approach and discuss its policy implications. A simple numerical example that models housing bubbles is used to illustrate the ease of implementing such models in practice using a spreadsheet. The final section presents the continuous time version of the model.