DotCom Mania: The Rise and Fall of Internet Stock Prices

1
DotCom ManiaThe Rise and Fall of Internet Stock
Prices

• Eli Ofek and Matthew Richardson

• 1998 2000 Internet Sector returns over 1000
• 6 of the market cap of all U.S. public
  companies
• 20 of all publicly traded equity volume

2
Theory/Premise

• Empirical support to the impact of short sale
  restrictions on stock prices in a setting with
  heterogeneous investors.
• Asset prices are equilibrium determined, however
  short sale restrictions force pessimistic
  investors out of the market.

3
Must Show

• Existence of relevant short sale restrictions for
  Internet Stocks.
• Sufficient heterogeneity across investors.

4
The Data

• January 1998 to February 2000
• 400 companies in pure internet sectors

5
Short Sales Constraints

• Why didnt sufficient capital get deployed
  against the internet sector to keep prices down?
• Investors were unwilling to short stocks
• Sufficient evidence shows mutual funds almost
  never short and hedge funds avoid risk adjusted
  excess return trades in highly volatile settings.
• Investors were unable to short stocks
• Very high short interest in internet shares
  (suggests saturation)
• Lower rebate rates (1.08 less than non-internet
  shares) shows internet shares had reached a limit
  in their short positions.
• Put-Call parity violations Call Put PV(K)
  S find that 36 of internet options violate
  the bound, while 24 for non-internet. Implies
  many more arbitrage violations for internets.

6
Heterogeneity Diverse beliefs held by investors
for Internet StocksBunch of retail investors
that dont know what they are doing.

• Data shows volume was high and participants were
  retail investors rather than institutions. Many
  mutual funds for internets were pass-throughs to
  retail.
• More retail investors were in market than under
  normal conditions leading to overly optimistic
  beliefs.
• Large responses to event driven information such
  as first day of IPO and end of quiet period
  when research coverage offloads shares to public
  (i.e. a 1 standard deviation decrease in block
  trading results in 30 increase in IPO first day
  price).

7
Lockup Expiration as Application of Theory

• Lockup expiration is lifting of short sale
  constraint
• 1. Permanent shift in amount of available
  shares
• 2. Shift to class of investors who have
  different beliefs
• 3. Members of new class are potential
  sellers
• 34 fall in stock price relative to the Internet
  Index

8
The Bubble Bursts

• Support for bubble is driven by combination of
  overly optimistic investors and momentum traders.
• Latter part of 1999 and spring of 2000 saw a huge
  number of lockup expirations.
• Almost 300 billion unlocked in short time
• New class of sellers overwhelms the optimistic
  ones.
• Insider selling continues at high level for 6
  months.
• Firms were also issuing new shares peaking in
  March-April 2000.
• Momentum investors say good bye.