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Quiet bubbles

  • Hong, Harrison
  • Sraer, David

Motivated by the recent subprime mortgage crisis, we explore whether speculative bubble models of equity based on investor disagreement and short-sales constraints can also provide an explanation for the overvaluation of debt contracts. We find that this is unlikely. 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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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 110 (2013)
Issue (Month): 3 ()
Pages: 596-606

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Handle: RePEc:eee:jfinec:v:110:y:2013:i:3:p:596-606
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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  1. 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.
  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. Hong, Harrison & Stein, Jeremy, 2007. "Disagreement and the Stock Market," Scholarly Articles 2894690, Harvard University Department of Economics.
  4. Asquith, Paul & Au, Andrea S. & Covert, Thomas & Pathak, Parag A., 2013. "The market for borrowing corporate bonds," Journal of Financial Economics, Elsevier, vol. 107(1), pages 155-182.
  5. Jennifer Koski & Jeffrey Pontiff, 1996. "How Are Derivatives Used? Evidence from the Mutual Fund Industry," Center for Financial Institutions Working Papers 96-27, Wharton School Center for Financial Institutions, University of Pennsylvania.
  6. 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.
  7. 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.
  8. 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.
  9. Harrison Hong & David Sraer, 2012. "Quiet Bubbles," NBER Working Papers 18547, National Bureau of Economic Research, Inc.
  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. Robin Greenwood & Samuel G. Hanson, 2011. "Issuer Quality and the Credit Cycle," NBER Working Papers 17197, National Bureau of Economic Research, Inc.
  12. 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.
  13. Harrison Hong & Jose Scheinkman & Wei Xiong, 2005. "Asset Float and Speculative Bubbles," Levine's Bibliography 122247000000000861, UCLA Department of Economics.
  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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