Asset Float and Speculative Bubbles

Abstract

We model the relationship between float (the tradable shares of an asset) and stock price bubbles. Investors trade a stock that initially has a limited float because of insider lock-up restrictions but the tradable shares of which increase over time as these restrictions expire. A speculative bubble arises because investors, with heterogeneous beliefs due to overconfidence and facing short-sales constraints, anticipate the option to resell the stock to buyers with even higher valuations. With limited risk absorption capacity, this resale option depends on float as investors anticipate the change in asset supply over time and speculate over the degree of insider selling. Our model yields implications consistent with the behavior of internet stock prices during the late nineties, such as the bubble, share turnover and volatility decreasing with float and stock prices tending to drop on the lock-up expiration date though it is known to all in advance.