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Quiet Bubbles

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  • Harrison Hong
  • David Sraer

Abstract

Commentaries on the credit bubble of 2003-2007 routinely equate it with earlier episodes like the Internet boom. While credits were over-priced like Internet stocks a decade before, we show, using a model based on disagreement and short-sales constraints, that this is where the similarity ends. Equity bubbles are loud: price and volume go together as investors speculate on capital gains from reselling to more optimistic investors. But this resale option is limited for debt since its upside payoff is bounded. Debt bubbles then require an optimism bias among investors. But greater optimism leads to less speculative trading as investors view the debt as safe and having limited upside. Debt bubbles are hence quiet—high price comes with low volume. We find the predicted price-volume relationship of credits over the 2003-2007 credit boom.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18547.

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Date of creation: Nov 2012
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Publication status: published as Hong, Harrison & Sraer, David, 2013. "Quiet bubbles," Journal of Financial Economics, Elsevier, vol. 110(3), pages 596-606.
Handle: RePEc:nbr:nberwo:18547

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  1. Paul Asquith & Andrea S. Au & Thomas R. Covert & Parag A. Pathak, 2010. "The Market for Borrowing Corporate Bonds," NBER Working Papers 16282, National Bureau of Economic Research, Inc.
  2. Wei Xiong & Hongjun Yan & Review Financial, 2007. "Heterogeneous Expectations and Bond Markets," Yale School of Management Working Papers amz2614, Yale School of Management, revised 01 Jun 2009.
  3. Joshua D. Coval & Jakub W. Jurek & Erik Stafford, 2009. "Economic Catastrophe Bonds," American Economic Review, American Economic Association, vol. 99(3), pages 628-66, June.
  4. Harrison Hong & Jose Scheinkman & Wei Xiong, 2005. "Asset Float and Speculative Bubbles," Levine's Bibliography 122247000000000861, UCLA Department of Economics.
  5. Chen, Joseph & Hong, Harrison & Stein, Jeremy C., 2002. "Breadth of ownership and stock returns," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 171-205.
  6. Jennifer Lynch Koski & Jeffrey Pontiff, 1999. "How Are Derivatives Used? Evidence from the Mutual Fund Industry," Journal of Finance, American Finance Association, vol. 54(2), pages 791-816, 04.
  7. Harrison, J Michael & Kreps, David M, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, MIT Press, vol. 92(2), pages 323-36, May.
  8. Robin Greenwood & Samuel G. Hanson, 2011. "Issuer Quality and the Credit Cycle," NBER Working Papers 17197, National Bureau of Economic Research, Inc.
  9. Baker, Malcolm & Greenwood, Robin & Wurgler, Jeffrey, 2003. "The maturity of debt issues and predictable variation in bond returns," Journal of Financial Economics, Elsevier, vol. 70(2), pages 261-291, November.
  10. Almazan, Andres & Brown, Keith C. & Carlson, Murray & Chapman, David A., 2004. "Why constrain your mutual fund manager?," Journal of Financial Economics, Elsevier, vol. 73(2), pages 289-321, August.
  11. Hong, Harrison & Stein, Jeremy, 2007. "Disagreement and the Stock Market," Scholarly Articles 2894690, Harvard University Department of Economics.
  12. Hong, Harrison & Sraer, David, 2013. "Quiet bubbles," Journal of Financial Economics, Elsevier, vol. 110(3), pages 596-606.
  13. Jose A. Scheinkman & Wei Xiong, 2003. "Overconfidence and Speculative Bubbles," Journal of Political Economy, University of Chicago Press, vol. 111(6), pages 1183-1219, December.
  14. Miller, Edward M, 1977. "Risk, Uncertainty, and Divergence of Opinion," Journal of Finance, American Finance Association, vol. 32(4), pages 1151-68, September.
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Cited by:
  1. Elias Albagli & Christian Hellwig & Aleh Tsyvinski, 2012. "A Theory of Asset Prices Based on Heterogeneous Information," Levine's Working Paper Archive 786969000000000347, David K. Levine.
  2. Gadi Barlevy, 2008. "A leverage-based model of speculative bubbles," Working Paper Series WP-08-01, Federal Reserve Bank of Chicago.
  3. Harrison Hong & David Sraer, 2012. "Quiet Bubbles," NBER Working Papers 18547, National Bureau of Economic Research, Inc.
  4. Elias Albagli & Christian Hellwig & Aleh Tsyvinski, 2011. "A Theory of Asset Pricing Based on Heterogeneous Information," NBER Working Papers 17548, National Bureau of Economic Research, Inc.

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