Advisors and asset prices: A model of the origins of bubbles |
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Authors: | Harrison Hong Jos Scheinkman Wei Xiong |
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Institution: | aDepartment of Economics, Princeton University, 26 Prospect Avenue, Princeton, NJ 08540-5296, USA |
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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. |
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Keywords: | Analyst forecast New technology bubble Reputation concern Heterogeneous beliefs |
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