Bubbles or Convenience Yields? A Theoretical Explanation with Evidence from Technology Company Equity Carve-Outs

Abstract

WP 2006-11 May 2006JEL Classification Codes: G10; G12; D50This paper offers an alternative explanation for what is typically referred to as an asset pricing bubble. We develop a model that formalizes the Cochrane (2002) convenience yield theory of technology company stocks to explain why a rational agent would buy an “overpriced” security. Agents have a desire to trade but short-sale restrictions and other frictions limit their trading strategies and enable prices of two similar securities to be different. Thus, divergent prices for similar securities can be sustained in a rational expectations equilibrium. The paper also provides empirical support for the model using a sample of 1996 - 2000 equity carve-outs