Advisors and Asset Prices: A Model of the Origins of Bubbles

45 Pages Posted: 15 Mar 2005  

Wei Xiong

Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

Jose A. Scheinkman

Columbia University; Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

Harrison G. Hong

Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

Date Written: December 21, 2005

Abstract

Many asset price bubbles occur during periods of excitement about new technologies. We focus on the role of advisors and the communication process with investors in explaining this stylized fact. Advisors are good-intentioned and want to maximize the welfare of their advisees. But only some understand the new technology (the tech-savvys); 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-savvys 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 yields a number of additional testable implications.

Keywords: Technology bubble, financial advisor, communication, reputation

JEL Classification: G10, G20

Suggested Citation

Xiong, Wei and Scheinkman, Jose A. and Hong, Harrison G., Advisors and Asset Prices: A Model of the Origins of Bubbles (December 21, 2005). AFA 2006 Boston Meetings Paper. Available at SSRN: https://ssrn.com/abstract=686325 or http://dx.doi.org/10.2139/ssrn.686325

Wei Xiong (Contact Author)

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jose A. Scheinkman

Columbia University ( email )

420 W. 118th Street
New York, NY 10027
United States

HOME PAGE: http://www.princeton.edu/~joses

Princeton University - Department of Economics ( email )

26 Prospect Avenue
Princeton, NJ 08544
United States
609-258-4020 (Phone)
609-258-6419 (Fax)

HOME PAGE: http://www.princeton.edu/~joses

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Harrison G. Hong

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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