We model the stock market as a timing game, in which arbitrageurs who are not
expected to be certainly rational compete over profit by bursting the bubble caused by
investors' euphoria. The manager raises money by issuing shares and the arbitrageurs
use leverage. If leverage is weakly regulated, it is the unique Nash equilibrium that the
bubble persists for a long time. This holds even if the euphoria is negligible and all
arbitrageurs are expected to be almost certainly rational. This bubble causes serious
harm to the society, because the manager uses the money raised for his personal benefit.
|