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Advisors and Asset Prices: A Model of the Origins of Bubbles

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  • Harrison Hong
  • Jose A. Scheinkman
  • Wei Xiong

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

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13504.

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Date of creation: Oct 2007
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Publication status: published as Hong, Harrison & Scheinkman, José & Xiong, Wei, 2008. "Advisors and asset prices: A model of the origins of bubbles," Journal of Financial Economics, Elsevier, vol. 89(2), pages 268-287, August.
Handle: RePEc:nbr:nberwo:13504

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Citations

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Cited by:
  1. 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.
  2. Lubos Pastor & Pietro Veronesi, 2009. "Learning in Financial Markets," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 361-381, November.
  3. 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.
  4. Joseph Gyourko, 2009. "Understanding Commercial Real Estate: Just How Different from Housing Is It?," NBER Working Papers 14708, National Bureau of Economic Research, Inc.
  5. 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.
  6. Chollete, Loran & Ning, Cathy, 2010. "Asymmetric Dependence in US Financial Risk Factors?," UiS Working Papers in Economics and Finance 2011/2, University of Stavanger.
  7. Edward L. Glaeser & Joseph Gyourko & Albert Saiz, 2008. "Housing Supply and Housing Bubbles," NBER Working Papers 14193, National Bureau of Economic Research, Inc.
  8. Hackethal, Andreas & Inderst, Roman & Meyer, Steffen, 2010. "Trading on Advice," CEPR Discussion Papers 8091, C.E.P.R. Discussion Papers.
  9. Anna Scherbina, 2013. "Asset Price Bubbles," IMF Working Papers 13/45, International Monetary Fund.
  10. 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.
  11. Chollete, Loran, 2011. "A Model of Endogenous Extreme Events," UiS Working Papers in Economics and Finance 2012/2, University of Stavanger.
  12. Robin Greenwood & Stefan Nagel, 2008. "Inexperienced Investors and Bubbles," NBER Working Papers 14111, National Bureau of Economic Research, Inc.
  13. Chollete, Loran & Jaffee, Dwight, 2009. "Economic Implications of Extreme and Rare Events," UiS Working Papers in Economics and Finance 2009/32, University of Stavanger.

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