The newsletter created by the Colorado College Finance and Administration Office.
The Dot-Com bubble of the late 1990s offers insight into the mentality of investors and money managers. The goal of this paper is to design a model utilizing fundamental valuation variables and determine its effectiveness at predicting price changes in U.S. equities during the 1996-2000 Dot-Com bubble. A successful model will provide insight into how investors can best navigate the turbulent financial waters brought on by the boom of a financial bubble and the following decline once the bubble has burst.
Using additions to the Standard and Poor's (S&P) 500 between 2000 and 2003, I explore the price and volume effects that the securities face on their respective addition announcement day. Attempts to identify price pressures surrounding an addition to the S&P 500 by focusing on opening and closing stock/index prices and trading volumes. The results are more consistent with the efficient market hypothesis than the price pressure hypothesis. Observed are large increases in trading activity leading to a shift in demand for the added security. However, positive abnormal returns are not concluded from this study
Exponential growth bias (EGB) is a largely unnoticed bias that plagues the financial decision making of most individuals in the United States. It is characterized as the tendency to linearize exponential compound saving and interest rates, and it shows itself through poor decision making around wrong estimates and/or no understanding of how money grows through time. Based on the theory that education and valid experience might tame EGB, a model was built to measure variable drivers of individual EGB related to exposure. Based on previous theory that more extreme situations demand more incentive for participation, it was hypothesized that the government dictated interest rates at times of individual’s first home purchases could subconsciously influence EGB, for two main reasons. First, a more expensive payment plan carries greater incentive to fully understand, and second, a first home purchase is a fundamentally monumental financial decision with potential to positively or negatively shape bias. A variable for interest rate at the time of a first home purchase was created a combined with more lifetime-housing-exposure variables theorized to influence EGB, to model overall effects of individual housing exposure on EGB. The results showed that government set interest rates hold no statistically significant influence on an individual’s current EGB, however, the marginal coefficients showed the correlations consistent with the theory. The model statistically significantly determined that the variables for number of homes purchased in a lifetime and price paid for a first home are inversely correlated with current EGB. In addition, income and education levels were statistically proven to be inversely correlated with current EGB.
