Contagious Speculation: A Nonevent that Made Stock Prices Soar

Abstract (Huberman)

A Sunday New York Times article on a potential development of new cancer-curing drugs caused EntreMed’s stock price to rise from 12.063 at the Friday close, to open at 85 and close near 52 on Monday. It closed above 30 in the three following weeks. The enthusiasm spilled over to other biotechnology stocks. The potential breakthrough in cancer research already had been reported, however, in the journal Nature, and in various popular newspapers ~including the Times! more than five months earlier. Thus, enthusiastic public attention induced a permanent rise in share prices, even though no genuinely new information had been presented.

Introductions (Via Huberman)

A CENTRAL TENET OF FINANCIAL ECONOMICS is that an asset should trade at the risk-adjusted present value of its expected future cash f lows. These expected future cash flows exist in people’s minds, and do not normally lend themselves  to direct observation.

An equilibrium price in a frictionless market does not tolerate disagreements among market participants: If some people deem the price too low, they will buy the asset; if others think it is too high, they will sell it ~short, if necessary!. Although the efficient-markets hypothesis predicts that price changes are unpredictable, it associates them with changes in traders’ beliefs about future cash flows or the appropriate discount rate. Beliefs change with the arrival of new information. Thus, in hindsight at least, we should be able to ascribe price changes to the arrival of specific new information. We examine this view in the context of a series of news reports in the media pertaining to EntreMed ~ENMD!, a biotechnology company, and other members of its sector.
The Sunday, May 3, 1998, edition of the New York Times reports on a recent breakthrough in cancer research, and mentions ENMD, a company with licensing rights to the breakthrough ~Kolata ~1998!!. The story’s impact on the stock prices was immediate, huge, and to a large extent permanent.

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01. February 2010 by Miguel Barbosa
Categories: Curated Readings, Finance & Investing | Leave a comment

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