COMPANIES &MARKETS - Inseader trading, cheap talk and big tickets - GLOBAL INVESTOR.
7 February 2000Financial Times
(c) 2000 The Financial Times Limited. All rights reserved
This is the cautionary
tale of the ball and the bubble: how "cheap talk" scared speculators and
drove down prices, but still left a student with cash in hand.
The bubble is any extreme
overvaluation of asset prices. The ball is the dance organised twice a
year by students of Insead, the prestigious business school near Paris -
specifically the summer ball which took place in May 1994.
assistant professor of finance at Purdue University, Indiana, draws the
two together in an intriguing new paper in which he develops a model to
show that "cheap talk" - inconsequential information, which should have
no bearing on market prices - can cause bubbles to burst.
This is timely.
Chat-rooms on the web are the new drug for many amateur investors, and
loose talk on the internet already affects shareholder behaviour.
Companies are devoting time and money to seeking out damaging rumours on
the internet and scotching them - or spreading a few useful rumours of
something new and true crops up: for instance, super-vigilant
cybersleuths could have spotted chat-room hints in advance of the recent
Time Warner-EMI deal, the America Online-Time Warner mega-merger, and
the announcement of talks (since aborted) between Procter &Gamble
and Warner Lambert. But most of what is posted is gossip rather than
Such cheap talk should
have little impact on prices. Most crashes are triggered by new
information, however trivial, relevant to pricing of the assets. Not,
however, in the case of the Insead ball.
The sale of tickets had
always attracted healthy speculation, via an e-mail system used by
Insead students and faculty. Tickets were limited, demand was often
fuelled by alumni returning for an annual reunion, and many of the
business school's students were hungry both for cash and for an
opportunity to put into practice a few of the trading strategies with
which they were familiar.
But at the beginning of
May 1994, with prices in the secondary market at FFr1,100 a ticket
(already about two thirds higher than the official price), a student put
out an e-mail castigating his peers for trying to make a fast buck.
He offered to set an
example by selling his tickets at face value and, a day later, claimed
he had done just that. The student never revealed whether he had held
the tickets at all, let alone sold them at the knock-down price.
But the bubble in the
aftermarket burst almost immediately. Prices fell 30 per cent and never
recovered, in spite of speculators' brazen attempts to prop up trading
by reminding fellow students that alumni would be prepared to buy at
almost any price in the days leading up to the dance.
Given that the arrival of
an "ethical" seller did not add any new information to the market about
likely demand for the tickets, Prof Rau supposes that the rogue e-mails
disrupted the common knowledge that everybody was in the market to
maximise his or her profit.
trading, and those students who were most worried about low demand for
tickets then preferred to sell at a lower price rather than risk being
unable to do so later.
Prof Rau's model - the
premise for which I have certainly oversimplified - also factors in the
unreliability of electronic communication, which he believes adds to the
risk of inconsequential information disrupting the market.
As for the possibility
that the ethical seller had successfully convinced the other students to
abandon the profit motive, Prof Rau dismisses that out of hand. "These
are MBA students," he says. "It's difficult to believe that everybody
suddenly became ethical."
Whether or not you
believe that US high-technology stocks are overvalued, the volume of
virtual investment chat is increasing, and with that the risk, if Prof
Rau is right, that cheap talk rather than concrete information will
induce the next correction. The technology-weighted Nasdaq Composite
index hit another new high on Friday, incidentally.
There was, however, a
happy ending to the tale of the ball and the bubble for one student.
Prof Rau himself managed to sell his ball tickets at an inflated price.
The buyer was an over-hasty Insead alumnus who was not aware that the
market had crashed - a case (incautious investors, please note) of lack
of common sense, rather than lack of common knowledge.
Copyright Financial Times Limited 2000. All Rights Reserved.