37 Pages Posted: 23 Jul 2003
Date Written: June 2003
The efficient markets hypothesis is based on the presumption that rational speculators would find it optimal to attack price bubbles and thus exert a correcting force on prices. We examine stock holdings of hedge funds during the time of the Technology Bubble on NASDAQ and find that the portfolios of these sophisticated investors were heavily tilted towards (overpriced) technology stocks. This does not seem to be the result of unawareness of the bubble: At an individual stock level, hedge funds reduced their exposure before prices collapsed, and their technology stock holdings outperformed characteristics-matched benchmarks. Our findings do not conform to the efficient markets view of rational speculation, but they are consistent with models in which rational investors can find it optimal to ride bubbles because of predictable investor sentiment and limits to arbitrage. Moreover, frictions such as short-sales constraints do not appear to be sufficient to explain why the presence of sophisticated investors failed to contain the bubble.
Keywords: Bubbles, Hedge Funds, Limits to Arbitrage
Suggested Citation: Suggested Citation
Nagel, Stefan and Brunnermeier, Markus K., Hedge Funds and the Technology Bubble (June 2003). AFA 2004 San Diego Meetings; EFA 2003 Annual Conference Paper No. 446. Available at SSRN: https://ssrn.com/abstract=423940 or http://dx.doi.org/10.2139/ssrn.423940