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.
Hong acknowledges support from the National Science Foundation through grant SES-0850404. Sraer gratefully acknowledges support from the European Research Council (Grant No. FP7/2007-2013 - 249429) as well as the hospitality of the Toulouse School of Economics. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Hong, Harrison & Sraer, David, 2013. "Quiet bubbles," Journal of Financial Economics, Elsevier, vol. 110(3), pages 596-606. citation courtesy of