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The Journal of Portfolio Management

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Method in the Madness: Bubbles, Trading, and Incentives

Jamil Baz, Josh Davis, Cristian Fuenzalida and Jerry Tsai
The Journal of Portfolio Management September 2020, 46 (8) 27-33; DOI: https://doi.org/10.3905/jpm.2020.1.168
Jamil Baz
is managing director at PIMCO in Newport Beach, CA
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Josh Davis
is managing director at PIMCO in Newport Beach, CA
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Cristian Fuenzalida
is vice president at PIMCO in Newport Beach, CA
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Jerry Tsai
is vice president at PIMCO in Newport Beach, CA
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Abstract

A long period of elevated asset valuation raises some fundamental questions. How can assets sustain prices way above their fundamental value for extended periods of time? Why are investors willing to bid up expensive assets? The authors show that for an expensive asset to sustain its valuation, the probability of further price increases must be high. Currency and equity option markets provide evidence. They also show that asset managers might have incentives to go long expensive assets if their prices are more likely to increase. Furthermore, the presence of return-chasing investors could drive prices above their value.

TOPICS: Options, equity portfolio management, currency

Key Findings

  • • For an expensive asset to sustain its valuation, the probability of further price increases must be high.

  • • Because expensive assets are likely to become more expensive, asset managers might have incentives to go long rather than short them.

  • • The presence of momentum and value investors could explain the life cycle of a bubble.

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The Journal of Portfolio Management: 46 (8)
The Journal of Portfolio Management
Vol. 46, Issue 8
September 2020
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Method in the Madness: Bubbles, Trading, and Incentives
Jamil Baz, Josh Davis, Cristian Fuenzalida, Jerry Tsai
The Journal of Portfolio Management Aug 2020, 46 (8) 27-33; DOI: 10.3905/jpm.2020.1.168

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Method in the Madness: Bubbles, Trading, and Incentives
Jamil Baz, Josh Davis, Cristian Fuenzalida, Jerry Tsai
The Journal of Portfolio Management Aug 2020, 46 (8) 27-33; DOI: 10.3905/jpm.2020.1.168
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  • Article
    • Abstract
    • WHY THE PARTY (LIKELY) GOES ON: THERE IS NO ANGRY WAY TO SAY “BUBBLE”
    • BUY HIGH, SELL LOW: INCENTIVES GONE AWRY
    • EVIDENCE FROM THE CURRENCY MARKETS
    • CALL SPREAD AND IMPLIED SKEWNESS
    • MOMENTUM AND FUNDAMENTALS: THE LIFE OF A BUBBLE
    • CONCLUSION
    • ADDITIONAL READINGS
    • ENDNOTES
    • REFERENCES
  • Info & Metrics
  • PDF (Subscribers Only)
  • PDF (Subscribers Only)

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