Optimal learning and new technology bubbles

Johnson, T (2002) Optimal learning and new technology bubbles. Working Paper. London Business School IFA Working Paper.

Abstract

It is widely believed that there is a fundamental linkage between major technological innovations, speculative fever, and wasteful overinvestment. This paper presents an equilibrium model of investment in a new industry, whose returntoscale is not known in advance. Overinvestment relative to the fullinformation case is then optimal as the most efficient way to learn about the new technology. Moreover, the initial overinvestment is accompanied by apparently inflated stock prices and apparently negative expected excess returns in the new industry, which are also fully rational. This suggests a new interpretation of what seem to be stock market driven real bubbles.