A Tale of two Bubbles: A Preliminary Look at the US Internet and Biotechnology Bubbles

Abstract

The term speculative bubble refers to a situation where prices diverge from their so-called “fundamental values” due to investor optimism rather than anything intrinsic to the values of the underlying assets themselves.¹ Economic historians have documented that one of the hallmarks of a speculative bubble is “new era” thinking, or the belief that some new price-enhancing circumstance is present in the world that somehow justifies a permanently higher level of valuation (e.g., Galbraith (1993); Shiller (2000)). Despite the world’s long history of speculative bubbles (see, e.g., Kindleberger (2000) or Garber (2001) for a detailed historical perspective), Welch (2001) recently identified stock market “frenzies” such as the most recent US Internet stock bubble as one of the top 10 challenges yet to be addressed by empirical financial research. Technology market observers and casual empiricists such as Perkins and Perkins (1999) have remarked that the Internet stock bubble has numerous parallels with the US biotechnology bubble that preceded it by less than a decade. Consistent with the “new era” thinking associated with other past speculative manias, for example, both the biotechnology and Internet stock bubbles were characterized by a belief that the new technology underlying these then-nascent stage industries would be revolutionary in their impact on the human condition. What seems most surprising is that investors in US technology stocks did not appear to learn from the biotech bubble and we thereby witnessed a similar, albeit more extreme, cycle of upward and ultimately downward price spirals when the Internet industry emerged less than a decade later.

“Those who do not learn from history are destined to repeat its mistakes.” — Santayana