Working Paper: NBER ID: w13504
Authors: Harrison Hong; Jose A. Scheinkman; Wei Xiong
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.
Keywords: Asset Price Bubbles; Investor Behavior; Advisor Influence
JEL Codes: G1; G14; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| techsavvy advisors (G24) | inflate forecasts (H68) |
| inflate forecasts (H68) | naive investors overvaluing assets (G19) |
| techsavvy advisors (G24) | naive investors overvaluing assets (G19) |
| mix of smart and naive investors (G40) | size of the bubble maximized (E32) |
| signaling behavior of techsavvy advisors (G24) | equilibrium price of tech stock biased upwards (D41) |
| marginal buyer's characteristics (naive investors) (G41) | asset price (G19) |