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Quiet Bubbles

  • Harrison Hong
  • David Sraer

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
Date of revision:
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
Note: AP CF
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  1. Hong, Harrison & Stein, Jeremy, 2007. "Disagreement and the Stock Market," Scholarly Articles 2894690, Harvard University Department of Economics.
  2. 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.
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  5. Hong, Harrison & Sraer, David, 2013. "Quiet bubbles," Journal of Financial Economics, Elsevier, vol. 110(3), pages 596-606.
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  9. J. Michael Harrison & David M. Kreps, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, Oxford University Press, vol. 92(2), pages 323-336.
  10. Wei Xiong & Hongjun Yan, 2010. "Heterogeneous Expectations and Bond Markets," Review of Financial Studies, Society for Financial Studies, vol. 23(4), pages 1433-1466, April.
  11. 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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  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. Robin Greenwood & Samuel G. Hanson, 2011. "Issuer Quality and the Credit Cycle," NBER Working Papers 17197, National Bureau of Economic Research, Inc.
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