The role of narratives in asset bubble formation: The case of the U.S. tech bubble

Abstract

From the feverish buying of tulips in Amsterdam in the 1600s to the recent U.S. frenzy in subprime mortgages, asset bubbles have proven to be a recurring economic phenomenon. While large asset bubbles, such as the U.S. stock bubble of the 1920s and the Japanese bubble of the 1980s, can result in pronounced, long-term financial and social consequences, even seemingly benign bubbles usually result in the misallocation of resources and budgetary problems for governments.In response to the regularity and consequences of these events, asset bubbles have been studied by a large number of scholars covering an increasingly diverse range of academic disciplines. Unfortunately, despite these ever-expanding streams of research, asset bubbles remain a poorly understood aspect of our economic worlds. What is worse, numerous scholars, practitioners, and policymakers feel as though we lack even a basic understanding of these events, a failure that is now undermining the reputation of today’s globalized, free market system.In this thesis, I argue that narratives play a central role in market speculation and thus the detailed and systematic study of narratives in these events provides a promising means by which to advance our understanding of how asset bubbles form. In light of this observation, I develop a conceptual framework, referred to as the institutionalized narrative (I/N) perspective of asset bubbles, and, using this framework, conduct a longitudinal study on the role that narratives played in the U.S. technology (tech) bubble of 1997 to 2000.The I/N perspective developed in this manuscript is a research lens and sensitizing mechanism that adopts a social constructionist view of financial markets where powerful market actors and institutions play a dominant role in shaping market behavior. In particular, the I/N perspective combines narrative research with institutional theory to explore how narratives that lead investors to expect significant capital gains, referred to as boom narratives, ultimately become the taken-forgranted context by which investors make decisions. Following this framework and using the U.S. tech bubble as a case study, this thesis investigates how boom narratives in tech stocks became a taken-for-granted, institutionalized aspect of investing in the mid to late 1990s and why efforts to challenge or deinstitutionalize these narratives repeatedly failed.These questions were investigated through an in-depth study of the events surrounding the U.S. tech bubble and 400 institutional texts (approximately 4,000 pages of raw data) that covered the years 1987, the year of the preceding market crash, to 2000, the peak of the tech bubble. Texts were gathered according to the three pillars of institutionalization, being the cognitive (represented by 65 speeches by Federal Reserve officials), normative (represented by 135 articles from The New York Times and Forbes), and regulative (represented by 200 statements by speakers at hearings from the U.S. Senate Committee on Banking, Housing, and Urban Affairs). Analysis was conducted through a unique combination of an event history database, keyword sampling, narrative analysis, discourse analysis, and process analysis.Drawing on the findings of this study, I outline a narrative theory of asset bubble formation. This theory contends that large-scale bubbles can emerge through three interrelated phases of narrating a crisis, narrating a recovery, and narrating a boom. If certain conditions are met in each phase, increasing levels of herd behavior, speculation, and illegal market practices are predicted to follow.In the first phase, narrating a crisis, powerful market actors are largely aligned in their exposition of negative narratives and view overregulation and business constraints as critical impediments in the economy. In the second phase, narrating a recovery, the dominant narratives tend to view continued deregulation as an economic enabler and the possibility of stricter regulations as a dangerous impediment, while normative texts start to produce increasingly positive narratives over time. In the third and final phase, narrating a boom, powerful market actors, particularly from the more prudent and powerful cognitive and regulative pillars, expound increasingly positive and optimistic narratives, while a range of alternatives to fundamental analysis start to dominate discourse.Given its focus on a critical and neglected aspect of asset bubble formation, being narratives, and its longitudinal consideration of narratives, actors, and events, the narrative theory offers a novel and rather detailed account of how large-scale bubbles can form. As a result of this novelty and detail, the theory serves to complement, integrate, and challenge existing thought on these episodes. In particular, the narrative theory highlights the importance of narratives and actions during a crisis and recovery, the highly influential role of cognitive and regulative texts, the replacement of fundamental analysis with a range of alternative means, and the incompleteness of existing theories on asset bubbles from a range of disciplines.