Rational fads in investor reactions to electronic commerce announcements: An explanation of the Internet bubble

This work proposes that information cascade theory can help to explain the formation of the Internet bubble. We propose that the bubble existed because a lack of good information about the potential value of electronic commerce led investors to rely on other investors’ private valuations of electronic commerce. We use the event study methodology to estimate returns to company announcements of electronic commerce initiatives in 1999 and 2000. We find that after controlling for network externalities and time trends, investors’ valuations of the returns to electronic commerce initiatives were significantly influenced by the market return from prior periods. Moreover, the relative weight placed on prior periods’ returns decreased as the variance of the prior periods’ returns increased. Both of the results are consistent with the behavior predicted by information cascade theory.