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# The Information-Technology Revolution and the Stock Market - PowerPoint PPT Presentation

The Information-Technology Revolution and the Stock Market Jeremy Greenwood and Boyan Jovanic AER 1999 A simple model ( a la Lucas 1978)

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The Information-Technology Revolution and the Stock MarketJeremy Greenwood and Boyan JovanicAER 1999

A simple model (a la Lucas 1978)

Simple exchange economy: many infinitely lived agents, and equally many “trees”, each tree yielding a “dividend” (output that goes to the owner) of dt at each period t.

The (stock market) price of a tree at time zero:

Notice that P0 is also the ratio: stock market value/output (S/GDP) since output=1.

News arrive at t=0 that a fraction x of existing trees will die at date T, and will be replaced by equally many better trees, yielding an output of 1+z. Thus output from T on will be:

Output over time is therefore,

The new trees will not trade in the stock market until they actually appear at T.

Type-1 tree – dies at T, liquidation value of zero; before T its price is,

Type-2 tree – lives forever. It stock market value:

Define,

Recall that,

Hence if x goes up, overall market value goes down.

• Ptdecreases with x:

• more trees are expected to be replaced by trees that are not yet in the market (type 1);

• higher x increases consumption in the future, hence lowering U’: alpha down, P2 down.

• Pt decreases with z: same as (ii)

• Pt increases with T: longer life of present trees, thus their (present) value goes up (recall beta<1, hence if T goes to infinity, max value).

Stock market value afterT

At date T new trees pop up and start to be traded. Output per tree, hence also consumption and dividends rise permanently to (1 + xz). Hence,

S falls faster than GDP in phase 1, but starts recovering before phase 2

• Big innovations may at first (and for quite a while) reduce overall Stock Market Value: the appearance of the new GPT means that the old one will soon be obsolete, and these are bad news!

• In the GJ model cannot trade in the new “trees”

• In HT can trade but the new firms are making zero profits; the old firms have constant profits over the first phase, but their horizon is shrinking!

“old tree” firms

The 1968 incumbents did badly, entrants did very well ~ 20 years later

IBM, Burroughs, Honeywell, NCR, Sperry Rand, DEC, Data General

Apple, Compaq, Dell, Gateway, Microsoft, Novel, Oracle, AOL, Yahoo, etc.