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Advisors and asset prices: A model of the origins of bubbles

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  • Hong, Harrison
  • Scheinkman, José
  • Xiong, Wei

Abstract

We develop a model of asset price bubbles based on the communication process between advisors and investors. Advisors are well-intentioned and want to maximize the welfare of their advisees (like a parent treats a child). But only some advisors understand the new technology (the tech-savvies); others do not and can only make a downward-biased recommendation (the old-fogies). While smart investors recognize the heterogeneity in advisors, naive ones mistakenly take whatever is said at face value. Tech-savvies inflate their forecasts to signal that they are not old-fogies, since more accurate information about their type improves the welfare of investors in the future. A bubble arises for a wide range of parameters, and its size is maximized when there is a mix of smart and naive investors in the economy. Our model suggests an alternative source for stock over-valuation in addition to investor overreaction to news and sell-side bias.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 89 (2008)
Issue (Month): 2 (August)
Pages: 268-287

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Handle: RePEc:eee:jfinec:v:89:y:2008:i:2:p:268-287

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Web page: http://www.elsevier.com/locate/inca/505576

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Citations

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Cited by:
  1. Lubos Pastor & Pietro Veronesi, 2009. "Learning in Financial Markets," NBER Working Papers 14646, National Bureau of Economic Research, Inc.
  2. Wiliam Branch & George W. Evans, . "Learning about Risk and Return: A Simple Model of Bubbles and Crashes," University of Oregon Economics Department Working Papers 2008-1, University of Oregon Economics Department.
  3. Anna Scherbina, 2013. "Asset Price Bubbles: A Selective Survey," IMF Working Papers 13/45, International Monetary Fund.
  4. Edward L. Glaeser & Joseph Gyourko & Albert Saiz, 2008. "Housing Supply and Housing Bubbles," NBER Working Papers 14193, National Bureau of Economic Research, Inc.
  5. Hackethal, Andreas & Inderst, Roman & Meyer, Steffen, 2010. "Trading on Advice," CEPR Discussion Papers 8091, C.E.P.R. Discussion Papers.
  6. Greenwood, Robin & Nagel, Stefan, 2009. "Inexperienced investors and bubbles," Journal of Financial Economics, Elsevier, vol. 93(2), pages 239-258, August.
  7. Ning, Cathy, 2010. "Dependence structure between the equity market and the foreign exchange market-A copula approach," Journal of International Money and Finance, Elsevier, vol. 29(5), pages 743-759, September.
  8. Kaustia, Markku & Lehtoranta, Antti & Puttonen, Vesa, 2013. "Does sophistication affect long-term return expectations? Evidence from financial advisers' exam scores," SAFE Working Paper Series 3, Center of Excellence SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
  9. Chollete, Loran, 2011. "A Model of Endogenous Extreme Events," UiS Working Papers in Economics and Finance 2012/2, University of Stavanger.
  10. Chollete, Loran & Jaffee, Dwight, 2009. "Economic Implications of Extreme and Rare Events," UiS Working Papers in Economics and Finance 2009/32, University of Stavanger.
  11. Joseph Gyourko, 2009. "Understanding Commercial Real Estate: Just How Different from Housing Is It?," NBER Working Papers 14708, National Bureau of Economic Research, Inc.
  12. Chollete, Loran & Ning, Cathy, 2010. "Asymmetric Dependence in US Financial Risk Factors?," UiS Working Papers in Economics and Finance 2011/2, University of Stavanger.

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