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

Harrison Hong, José Scheinkman, Wei Xiong

Research output: Contribution to journalArticle

39 Scopus citations

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.

Original languageEnglish (US)
Pages (from-to)268-287
Number of pages20
JournalJournal of Financial Economics
Volume89
Issue number2
DOIs
StatePublished - Aug 1 2008

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

Keywords

  • Analyst forecast
  • Heterogeneous beliefs
  • New technology bubble
  • Reputation concern

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