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

Harrison Hong, Jose Scheinkman () and Wei Xiong

No 13504, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: G1 G14 G2 (search for similar items in EconPapers)
Date: Written
Note: AP CF
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Related works:
Working Paper: Advisors and Asset Prices: A Model of the Origins of Bubbles (2005)
Journal Article: Advisors and asset prices: A model of the origins of bubbles (2008)
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