Imperfect knowledge, liquidity and bubbles

Insufficient liquidity can lead to substantial movements in asset prices. There is a single asset traded in a centralized market that facilitates exchange in decentralized trade. If the asset is in short supply the price includes a liquidity premium. Traders have imperfect knowledge about future asset prices and estimate, in real-time, an econometric forecasting model. A permanent decrease in the supply of assets, or an increase in collateral requirements, can lead to over-shooting of the price. When price includes a liquidity premium there can be recurrent bubbles and crashes. Liquidity and adaptive learning play key roles in fitting the empirical distribution of price-dividend ratios.