The Role of Investor Sentiment in the Dot-Com Bubble

Figure 1: An illustration of how Behavioural Biases can lead to irrational investing Source: MarketXLS The Dot-com Era stands as a testament to the tie between human psychology and financial markets, where behavioural biases propelled speculative trading to unprecedented heights before the bubble burst. If we go deeper into these biases and their underlying causes we can get invaluable insights into the dynamics of market bubbles. Overconfidence Bias: Overconfidence bias, deeply rooted in human nature, led investors to show an exaggerated belief in their ability to predict the future trajectory of technology stocks . The rapid advancement of the internet and the perceived paradigm shift in business models fuelled this overconfidence, blinding investors to the inherent risks. They erroneously assumed that their knowledge of technology represented an edge in navigating the market, which therefore fuelled speculative trading activities and inflated stock prices beyond rational levels. He

The impact of investor sentiment on dot-com stock prices during the late 1990s and early 2000s was profound and multifaceted. Investor sentiment, characterized by exuberance and irrational optimism, played a pivotal role in driving dot-com stock prices to unsustainable levels. This sentiment was fuelled by various factors , including technological innovation, fear of missing out (FOMO), speculative trading, overvaluation, and media hype; all of which led to overconfidence with investors (see Figure 1). Figure 1: A visual representation on how FOMO led to overconfidence as seen during the Dot-Com Bubble Source: FasterCapital The rapid growth and potential of the internet as a transformative technology led investors to believe that dot-com companies represented the future of business and commerce. This optimism was further exacerbated by a fear of missing out on potential gains, resulting in a herd mentality among investors who rushed to invest in dot-com stocks regardless of their

Investor Sentiment: The Rise of the Digital Noise Traders Figure 1: The NASDAQ Composite Index Pre and Post Dotcom Bubble  Source: Quartz The dotcom bubble culminated in the demise of numerous internet-based enterprises, including Pets.com and Webvan, while others such as Amazon and eBay survived the bubble bursting and emerged as industry behemoths. Investor losses during this period were massive, estimated at approximately $5 trillion (source: CFI ) by 2002, shown by the downfall of the NASDAQ Composite Index in Figure 1. The exuberance surrounding internet companies led to inflated stock prices, driven primarily by speculative fervour rather than intrinsic value. Investor Sentiment Explained, and how this links to the Dot-Com Bubble: Markets are efficient by definition when investors are rational. However, this speculative fervour mentioned above is one example of non- Bayesian expectation formation. Investors often do not look at the levels of final wealth they can attain but at