``Slimming of power-law tails by increasing market returns

Abstract: We introduce a simple generalization of rational bubble models which removes the fundamental problem discovered by [Lux and Sornette, 1999] that the distribution of returns is a power law with exponent less than 1, in contradiction with empirical data. The idea is that the price fluctuations associated with bubbles must on average grow with the mean market return r. When r is larger than the discount rate r_delta, the distribution of returns of the observable price, sum of the bubble component and of the fundamental price, exhibits an intermediate tail with an exponent which can be larger than 1. This regime r>r_delta corresponds to a generalization of the rational bubble model in which the fundamental price is no more given by the discounted value of future dividends. We explain how this is possible. Our model predicts that, the higher is the market remuneration r above the discount rate, the larger is the power law exponent and thus the thinner is the tail of the distribution of price returns.

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