FIN-01-037

DotCom Mania: The Rise and Fall of Internet Stock Prices

November 2001

Eli Ofek and 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.


Eli Ofek
Institution: Stern School of Business, New York University, 44th West 4th Street, New York, NY 10012
Telephone: (212) 998-0356
Fax: (212) 995-4233
Email: eofek@stern.nyu.edu
Homepage:http://www.stern.nyu.edu/~eofek

Matthew Richardson
Institution: Stern School of Business, New York University, 44th West 4th Street, New York, NY 10012
Fax: (212) 995-4233
Email: mrichard@stern.nyu.edu
Homepage:http://www.stern.nyu.edu/~mrichard

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