G. Bakshi and L. Wu: Investor Irrationality and the Nasdaq Bubble

July 22, 2006

This paper investigates whether the rise and fall of the Nasdaq at the turn of the century can be justified by changes in return risk, and whether investors are driven by irrational euphoria with systematic shifts in the market prices of risks (e.g., inexplicable changes in risk aversion and/or subjective probabilities deviating substantially from the objective states of the world). Based on model specification that accommodates fluctuations in both risk levels and market prices of different sources of risks, our analysis provides three new insights.