Leverage and bubbles: a note on the Spanish property market between 1998 and 2006

Abstract

Financial leverage means the debt taken to make a property investment is revalued in the same proportion as the speculative asset acquired. When the expected price rises above a certain threshold, it becomes rational to take on long-term debt to finance a short-term investment. This causes bubbles, which can have disastrous consequences for the economy as a whole. We model here the economics of speculative leverage and calculate the speculative threshold for the Spanish property market over the last decade, showing how far prices were above the mark.

Notes

¹ The slope of FR_t in Equation 3(3) can be written as 1/(P ₀ – M ₀ + R_t + C_t ) (given Equation 1(1)), where (M ₀ – R_t ) is the outstanding principal payable.