Wednesday, November 17, 2004

Investor Rationality

The New York Times reports that
Shares of Google, the newly public Web search company, fell 6.7 percent yesterday as selling restrictions were lifted on 39 million shares held by employees and early investors.
This bothers me for it reveals that stock prices are, in some short-term, based simply on supply and demand characteristics, rather than the fundamentals of the stock. Yesterday, investors knew that there existed these 39 million shares and so the fact that they are traded today should not have an impact on the share price: a share yesterday owned the same amount of the company as a share today. So the fact that the amount of supply moves stocks is troubling in view of investor irrationality (this is a point made by John Cassidy in dot.con). Also, it troubles the assumption of rational expectations: investors knew that these shares would be released, so the possible fall in stock price should have already occurred, given that the stock price is supposed to reflect a valuation on the company.

Of course, this just shows that stocks can sometimes behave like commodities -- in which case the price reflects something, what people are willing to pay, but does not necessarily behave as stock as reflecting-all-possible-information theory would seem to indicate.

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