Abstract: In modern financial markets, the prevalence of information asymmetry and borrowing-lending investment behavior, as well as the problems of the resulting risk-benefit asymmetry and risk transfer, would lead to asset price inflation and thus the formation of foam. Based on the selection of representative borrowing-lending investment activities of the investors as the research subject, through the introduction of the loan to value ratio (LTV) for further expansion of the Allen-Gale model, this paper tries to illustrate the internal mechanism of the formation of asset price bubble and its impact on financial markets by applying the dynamic adjustment of LTV. Through simulative analysis, it is found that when interest rates stay unchanged, the greater the LTV, the bigger the asset price bubbles; while the LTV remains constant, the lower the interest rates, the greater the level of asset price bubbles. Therefore, the key to contain asset price bubbles is to lower the LTV and to raise interest rates.

Key words: investment lending; asset price bubbles; loan to value ratio; Allen-Gale model