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Irrationality of Biotech Investors: the EntreMed case study

This article is completely based on Huberman, Regev 2001 - Contagious Speculation and a Cure for Cancer: A Nonevent that Made Stock Prices Soar


One of the main assumption in classical Efficient Market Hypotesis is that an asset should trade at the risk-adjusted present value of its expected future cash flow.

Rational investors form beliefs on these expected future cash flows, and as soon as new information are available, they change their beliefs and price adjusts.

This paper study the case of biotech company “EntreMed” (ENMD), and its related disruptive news reporting a recent breakthrough in cancer research for which ENMD owned licensing rights.

In this case-study, two main behavioral economics findings are well analyzed: the framing effect and (positive) contagion.

FRAMING EFFECT

In November 1997 the news had been firstly published as a scientific piece in Nature and in the popular press.

The closing price of ENMD was 11.875 on November 26, and on November 28 it was 15.25; thus, the news caused a price appreciation of 28.4 percent, 

The unusually high trading volume on November 28 and December 1 indicates that the market paid attention to the news. On the whole, an adherent of the efficient-market hypothesis would argue that the market digested the news in a timely and robust fashion.

The exact same news framed in a much more prominent way on May 1998 let the ENMD’s stock price skyrocket.

It had closed at 12.063 on the Friday before the article appeared, opened at 85 and closed at 51.81 on Monday, May 4. The Friday-close-to-Monday-close return of 330 percent!



POSITIVE CONTAGION

The second part of the paper shows that there has also been an increase in stock price and volumes of other biotech companies, with especially 7 other biotech firms that exceeded 25% returns.

These may be caused by the market that recognized potential spillover effects and surmise that other firms may benefit from the innovation, but then why they didn’t invest five motnhs earlier? The authors believe that they might have speculated on noise trader behavior.

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