Representative bubbles and deleveraging

Purpose The causes for the formation of a bubble in the collateral market when agents are provided with homogeneous expectations are explored. This bubbly dynamics will define a sufficient condition for deleveraging. Design/methodology/approach Theoretical approach with neutral deleveraging. Findings Findings of the study are defined sufficient conditions for a behavioral rational bubble's formation in a market of collateral and the subsequent deleveraging. The crowd-in effect of the representative bubble is caused by errors in extrapolating information and thus by representativeness, while the crowd-out effect of deleveraging is set off by reverting to a rational heuristic. Research limitations/implications The limit is that it is a homogeneous expectations approach, the implication is that cannot be rational speculation. Practical implications Even in a simple model of homogeneous expectations a bubble may arise with serious effect on the demand side: models that detect just rational mispricings cannot account for behavioral components that have financial and real effects. Originality/value The paper defines how deleveraging may occur even in case of homogeneous expectations. The latter should not be seen just as a limit but also as a signal of the importance of being aware of behavioral components.