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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. Joseph Gyourko, 2009. "Understanding Commercial Real Estate: Just How Different from Housing Is It?," NBER Working Papers 14708, National Bureau of Economic Research, Inc.
  2. Chollete, Loran, 2011. "A Model of Endogenous Extreme Events," UiS Working Papers in Economics and Finance 2012/2, University of Stavanger.
  3. 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.
  4. Chollete, Loran & Ning, Cathy, 2010. "Asymmetric Dependence in US Financial Risk Factors?," UiS Working Papers in Economics and Finance 2011/2, University of Stavanger.
  5. Branch, William A. & Evans, George W., 2010. "Learning about Risk and Return: A Simple Model of Bubbles and Crashes," SIRE Discussion Papers 2010-33, Scottish Institute for Research in Economics (SIRE).
  6. Hackethal, Andreas & Inderst, Roman & Meyer, Steffen, 2010. "Trading on Advice," CEPR Discussion Papers 8091, C.E.P.R. Discussion Papers.
  7. Chollete, Loran & Jaffee, Dwight, 2009. "Economic Implications of Extreme and Rare Events," UiS Working Papers in Economics and Finance 2009/32, University of Stavanger.
  8. Robin Greenwood & Stefan Nagel, 2008. "Inexperienced Investors and Bubbles," NBER Working Papers 14111, National Bureau of Economic Research, Inc.
  9. Lubos Pastor & Pietro Veronesi, 2009. "Learning in Financial Markets," NBER Working Papers 14646, National Bureau of Economic Research, Inc.
  10. 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, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
  11. Glaeser, Edward L. & Gyourko, Joseph & Saiz, Albert, 2008. "Housing supply and housing bubbles," Journal of Urban Economics, Elsevier, vol. 64(2), pages 198-217, September.
  12. Stefano Giglio & Matteo Maggiori & Johannes Stroebel, 2014. "No-Bubble Condition: Model-free Tests in Housing Markets," NBER Working Papers 20154, National Bureau of Economic Research, Inc.
  13. Anna Scherbina, 2013. "Asset Price Bubbles," IMF Working Papers 13/45, International Monetary Fund.

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