Advisors and asset prices: A model of the origins of bubbles

Harrison Hong, Jose Scheinkman and Wei Xiong

Journal of Financial Economics, 2008, vol. 89, issue 2, 268-287

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.

Date: 2008
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Working Paper: Advisors and Asset Prices: A Model of the Origins of Bubbles (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:89:y:2008:i:2:p:268-287

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