Hedge Funds and the Technology Bubble




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    • Markus K. Brunnermeier is affiliated with Princeton University and CEPR and Stefan Nagel with Stanford University. We would like to thank Cliff Asness, Richard Brealey, Smita Brunnermeier, Elroy Dimson, Gene Fama, Bill Fung, Rick Green (the editor), Martin Gruber, Tim Johnson, Jon Lewellen, Andrew Lo, Burt Malkiel, Narayan Naik, Aureo de Paula, Lukasz Pomorski, Jeff Wurgler, and two anonymous referees as well as participants at the European Finance Association Meetings, the Fall 2002 NBER Behavioral Finance Meetings, and in seminars at the Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, University of Chicago, London Business School, MIT, Northwestern University and Princeton University for useful comments. Part of this research was undertaken while both authors were visiting the Sloan School of Management at MIT and while Nagel was a doctoral student at London Business School. Brunnermeier acknowledges research support from the National Science Foundation (NSF-Grant no. 021-4445). Nagel is grateful for financial support from the ESRC, the Lloyd's Tercentenary Foundation, the Kaplanis Fellowship, and the Centre for Hedge Fund Research and Education at London Business School.


This paper documents that hedge funds did not exert a correcting force on stock prices during the technology bubble. Instead, they were heavily invested in technology stocks. This does not seem to be the result of unawareness of the bubble: Hedge funds captured the upturn, but, by reducing their positions in stocks that were about to decline, avoided much of the downturn. Our findings question the efficient markets notion that rational speculators always stabilize prices. They are consistent with models in which rational investors may prefer to ride bubbles because of predictable investor sentiment and limits to arbitrage.