Working Paper: NBER ID: w18547
Authors: Harrison Hong; David Sraer
Abstract: 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.
Keywords: Credit Bubbles; Equity Bubbles; Investor Behavior; Financial Crisis
JEL Codes: G02; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Investor optimism (G31) | Trading activity (G19) |
| Debt bubbles (H63) | Speculative trading (G13) |
| Optimism (D84) | Perception of debt as safer (G51) |
| Price increase (D49) | Trading volume (G15) |
| Equity bubbles (G12) | High prices and high trading volume (G19) |
| Debt bubbles (H63) | High prices and low trading volume (G19) |
| Credit boom (F65) | Price-volume relationship (D46) |