We analyze an overlapping generations economy with financial frictions and accumulation of both physical and intangible capital. The key difference between them is that intangible capital cannot be used as collateral for borrowing.
As intangibles become more important in production, financial frictions tighten and equilibrium interest rates decline, creating the conditions for the emergence of rational bubbles. We also analyze the question of dynamic efficiency, demonstrating that, in the presence of financial frictions, neither the interest rate test nor the test proposed by Abel et al. (1989) are appropriate.
Finally we show that, in general, rational bubbles are not Pareto improving in our framework.
Author/Editor:Giglio, Stefano; Severo,Tiago.Authorized for Distribution:November 01, 2011.Series:Working Paper No. 11/271. This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.
