The valuation and market rationality of Internet stock prices

This paper provides an analysis of some existing as well as new evidence of the relation between market prices and fundamentals in the Internet sector over the period January 1998 to February 2000. Appealing to results across a broad class of outcomes, we demonstrate a strong, circumstantial case against market rationality. In particular, we investigate (i) the level of Internet stock prices given their underlying fundamentals, (ii) responses of stock prices to information-based events, and (iii) the volatility of Internet prices. We review several potential explanations of these phenomena, including one based on heterogeneous beliefs across investors who are subject to short sales constraints. We provide a discussion of the empirical evidence supporting this latter explanation.