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. 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 intemet stocks being tied to the increase in the number of sellers to the market via expiration of lockup agreements.

This paper documents that hedge funds did not exert a correcting force on stock prices during the technology bubble. Instead, they were heavily invested in technology stocks. This does not seem to be the result of unawareness of the bubble: Hedge funds captured the upturn, but, by reducing their positions in stocks that were about to decline, avoided much of the downturn. Our findings question the efficient markets notion that rational speculators always stabilize prices. They are consistent with models in which rational investors may prefer to ride bubbles because of predictable investor sentiment and limits to arbitrage.

We present a model in which an asset bubble can persist despite the presence of rational arbitrageurs. The resilience of the bubble stems from the inability of arbitrageurs to temporarily coordinate their selling strategies. This synchronization problem together with the individual incentive to time the market results in the persistence of bubbles over a substantial period. Since the derived trading equilibrium is unique, our model rationalizes the existence of bubbles in a strong sense. The model also provides a natural setting in which news events, by enabling synchronization, can have a disproportionate impact relative to their intrinsic informational content.

Not necessarily. The fundamental value of a firm increases with uncertainty about average future profitability, and this uncertainty was unusually high in the late 1990s. We calibrate a stock valuation model that includes this uncertainty, and compute the level of uncertainty that is needed to match the observed Nasdaq valuations at their peak. This uncertainty seems plausible because it matches not only the high level but also the high volatility of Nasdaq stock prices. We also show that uncertainty about average profitability has the biggest effect on stock prices when the equity premium is low.

What are the equilibrium features of a Þnancial market where a sizeable proportion of traders face reputational concerns? This question is central to our understanding of Þnancial markets that are increasingly dominated by institutional investors. We construct a model of delegated portfolio management that captures key features of the US mutual fund industry and embed it in an asset pricing framework. We thus provide a formal model of Þnancial equilibrium with career concerned agents. Fund managers differ in their ability to understand market fundamentals, and in every period investors choose a fund. In equilibrium, the presence of career concerns induces uninformed fund managers to churn, i.e. to engage in trading even when they face a negative expected return. As churning plays the role of noise trading, the asset market displays non-fully informative prices and positive (and high) trading volume. The equilibrium relationship between fund return and net fund ßows displays a skewed shape that is consistent with stylized facts. The robustness of our core results is probed from several angles.

Using data on cross-sectional dispersion in forecasters’long- and short-run predictions of macroeconomic variables, we identify key sources of disagreement. Dispersion among forecasters is highest at long horizons where private information is of limited value and lower at short forecast horizons. Moreover, differences in views persist through time. Such differences in opinion cannot be explained by differences in information sets; our results indicate they stem from heterogeneity in priors or models. We also find evidence that differences in opinion move countercyclically, with heterogeneity being strongest during recessions where forecasters appear to place greater weight on their prior beliefs. Keywords: Dispersion in beliefs, heterogeneous information, term structure of forecasts.

We suggest a simple asset market model in which we analyze competitive and strategic behavior simultaneously. If for competitive behavior two-fund separation holds across periods then it also holds for strategic behavior. In this case the relative prices of the assets do not depend on whether agents behave strategically or competitively. Those agents acting strategically will however invest less in the common mutual fund. Constant relative risk aversion and absence of aggregate risk are shown to be two alternative sufficient conditions for two-period fund separation. With derivatives further strategic aspects arise and strategic behavior is distinct from competitive behavior even for those utility functions leading to two-fund separation. Keywords: strategic behavior, competitive behavior, two-fund-separation, CAPM. JEL classification: C72, G11, D83. We like to thank Piero Gottardi, Enrico De Giorgi, and Rüdiger Frey for valuable discussions. Financial support by the national centre of competence in research “Financial Valuation and Risk Management” is gratefully acknowledged. The national centers in research are managed by the Swiss National Science Foundation on behalf of the federal authorities. 2 1

This paper analyzes the effects of information leakage on trading behavior and market efficiency. It shows that a trader who receives a leaked signal prior to a public announcement can exploit this private information twice. First, when he receives his signal, and second, at the time of the public announcement. The latter effect occurs because he can best infer the extent to which his information is already reflected in the pre-announcement price. The analysis also shows that the early-informed trader trades aggressively prior to the public announcement and intends to unwind part of the acquired position after it. While information leakage makes the price process more informative in the very short-run, it reduces its informativeness in the long-run. Hence, the analysis provides strong support for SECs Regulation FD.

We generalize asset pricing theory by merging it with ideas taken from corporate governance. We do this by introducing a so called distinguished player defined by the ability to enhance the value of a company facing private effort costs. The current fundamental value of the company hinges then on the distinguished player’s prospective effort which is determined by his ex post holdings and hence by the outcome of the trading game. In this article we characterize underpricing trade equilibria for a general class of market mechanisms. They display interesting theoretical properties. Shares of the company are traded below their correctly anticipated value in order to discourage the distinguished player to sell and withdraw from the company. In particular, this implies a substantial generalization and reinterpretation of the traditional no-arbitrage condition towards a game-theoretic understanding. No rational investor can gain by deviating even though shares of the company are traded below their true value. An intriguing empirically testable prediction of this model are excess-returns for companies with a publicly visible distinguished player which if con…rmed would falsify models based on the traditional no-arbitrage condition.

Individual investors often invest actively and lose thereby. Social interaction seems to exacerbate the bias toward active trading. In the model here, conversational biases in the social transmission of performance information favor active over passive investment strategies. Senders ’ propensity to communicate their returns is increasing in returns. Receivers’ propensity to attend to and be converted by senders is increasing and convex in sender return. Active strategies (high variance, skewness, and personal involvement) dominate the population unless the mean return penalty to active investing is too large. Thus, the model can explain overvaluation of assets with these characteristics even if investors have no inherent preference over them.