Finance Roundtable News

Explaining the dot.com debacle

“It is commonly believed that there was a Nasdaq ‘bubble' in the late 1990s,” said Pietro Veronesi, Associate Professor of Finance, at a presentation sponsored by GSB Finance Roundtable on February 10 at Gleacher Center. According to Veronesi, that's not necessarily a self-evident truth. “Uncertainty about long-term profitability was particularly high for tech stocks at the time, and uncertainty increases firm value.” As proof, Veronesi shared a valuation model, developed and calibrated in a research paper written with colleague Lubos Pástor, Associate Professor of Finance, that includes this uncertainty and provides a plausible reason for the dot.com debacle.

The unusually swift rise and precipitous fall of stock prices on the Nasdaq at the turn of the millennium led many to believe that the prices of technology stocks exceeded their fundamental values, thus the description “bubble.” But, according to Veronesi, Nasdaq stock prices in the late 1990s were not only high, they were also highly volatile, and both facts are consistent with high uncertainty about average future profitability. Uncertainty about growth rates of technology firms increased in the last decade as a “new era” of technological revolution was embraced, and historical experience was discounted. Veronesi's model matches both the high prices and high volatility and shows the effects of uncertainty could be strong enough to rationalize the valuations. “We don't claim that there was no ‘bubble,' we only argue that it is not obvious that there was one,” he said.

—Donna Eckert