44 Pages Posted: 22 Feb 2011 Last revised: 21 Nov 2011
Date Written: February 22, 2011
Classic speculative bubbles are loud: price is high and so are price volatility and share turnover. The credit bubble of 2003-2007 is quiet: price is high but price volatility and share turnover are low. We develop a model, based on investor disagreement and short-sales constraints, that explains why credit bubbles are quieter than equity ones. Since debt up-side payoffs are bounded, debt is less sensitive to disagreement about asset value than equity and hence has a smaller resale option and lower price volatility and turnover. While optimism makes both debt and equity bubbles larger, it makes debt mispricings quiet but leaves the loudness of equity mispricings unchanged. Our theory suggests a taxonomy of bubbles.
Keywords: Bubbles, Financial Crisis, Sub-Prime Mortgage Securities, Credit
JEL Classification: G12, E50
Suggested Citation: Suggested Citation
By Andrew Ang