Does Innovation Cause Stock Market Runups? Evidence from the Great Crash

The idea that technological revolutions can explain major swings in stock market value is occupying an increasingly prominent role in the literature on the economics of financial markets. Both the 1990s and the 1920s stock market runups have been linked to the arrival of new technologies and the accumulation of intangible capital by firms (Robert Hall 2001; Bart Hobijn and Boyan Jovanovic 2001; John Laitner and Dmitriy Stolyarov 2003; Ellen McGrattan and Edward Prescott 2004; Lubos Pastor and Pietro Veronesi 2005). No study, however, has analyzed the value of these assets over the life cycle of a stock market boom and bust. This is an important omission, since the performance of the stock market implies that the value of new technology fell away sharply during the crashes of October 1929, and March 2000 (Stephen LeRoy 2004). How important are technologically related assets in driving the stock market upward and in precipitating a crash? How do investors respond to new innovations after the market has initially faltered? This article attempts to answer these questions by looking at the stock market’s changing value of corporate patentable assets over the life cycle of the 1929 Great Crash, one of the most important events in American economic and financial history. According to the dominant view in the literature, rising stock market prices during the 1920s can be explained away by speculation and irrational exuberance. Bradford DeLong and Andrei Shleifer (1991) contend that closed-end funds traded at a significant premium over their fundamental value, while Peter Rappoport and Eugene White (1994) find a sharp increase in the risk premium on brokers’ loans that were used to fund equity purchases. DeLong and Shleifer conclude that the 1929 stock market was overvalued by at least 30 percent. The alternative view emphasizes new technology and the intangible assets of firms (Irving Fisher 1930). In this tradition, McGrattan and Prescott (2004) argue that on the eve of the crash the stock market was Does Innovation Cause Stock Market Runups? Evidence from the Great Crash