Friday, October 04, 2013

Behavioral Economics and Tesla's Stock Price Dynamics After the Fire

A Tesla car caught on fire and this event "caused" a huge drop in Tesla's stock price.  Under the efficient markets hypothesis, how much should the stock price move when this "new news" arrives?  While event studies are now "old hat", permit me to blog about this and its implications for testing neo-classical versus behavioral views on how the economy works.

Suppose that stock investors believed that car buyers viewed this fire as a fluke and just as bad luck. In this case, there would be no Tesla stock price decline when the fire occurs because aggregate demand for Tesla EV vehicles does not change.

For the shock "to cause" an effect on stock prices suggests that investors believe that potential car buyers will be spooked by the shock.  But, how do the investors know this? Did they use Twitter searches for "Tesla and Fire" to create a fear index?  How would we know whether pessimistic investors have sold too much Tesla?

We celebrate diversity and in our diverse society people differ with respect to their desires to purchase electric vehicles and with respect to how they process news information such as the recent fire.  In Behavioral Economics, people like Matt Rabin say that there is a "Law of Small Numbers" such that people over-react to new news.  The Tesla stock price dynamics suggests that some investors embrace this logic.  Will Chicago EMH adherents now purchase the Tesla stock?

Has a paper been written on whether investors who purchase shocked companies after nasty events earn abnormally high profits?

I recognize that another random variable here is whether Tesla must have a large recall for the cars it has sold but keep in mind that it hasn't sold many!  This issue is all about heterogeneous beliefs about this young company's future and the razor's edge that bad publicity is believed to potentially sink such a company.

I have recorded a video about this and posted it here on YouTube.