Working Paper: NBER ID: w8630
Authors: Eli Ofek; Matthew Richardson
Abstract: This paper provides one potential explanation for the rise, persistence and eventual fall of internet stock prices. Specifically, we appeal to a model of heterogenous agents with varying degrees of beliefs about asset payoffs who are subject to short sales constraints. In this framework, it is possible that 'optimistic' investors overwhelm 'pessimistic' ones, leading to prices not reflecting fundamental values about cash flows summarized by aggregate beliefs. Empirical support for this explanation is provided by exploring the behavior of internet stock prices during the period January 1998 to November 2000. In particular, we document four important elements to our story: (i) the high level of internet stock prices given their underlying fundamentals, (ii) responses of stock prices to a shift towards potentially optimistic investors, (iii) empirical results consistent with shorting being at its maximum possible level for internet stocks, and (iv) the eventual fall, or bubble bursting, of internet stocks being tied to the increase in the number of sellers to the market via expiration of lockup agreements.
Keywords: Internet Stocks; Market Behavior; Heterogeneous Beliefs; Short Sales Constraints; Asset Pricing
JEL Codes: G
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimistic investors (G40) | inflated prices (E31) |
| entry of optimistic investors (G24) | increase in stock prices (G10) |
| absence of pessimistic investors (G19) | sustained mispricing (G19) |
| short sale constraints (G33) | inflated asset prices (E31) |
| expiration of lockup agreements (G33) | decline in stock prices (G10) |
| inflated prices (E31) | not reflect fundamental values (D46) |