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The Information-Technology Revolution and the Stock Market Jeremy Greenwood and Boyan Jovanic AER 1999 A simple model ( a la Lucas 1978)

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## The Information-Technology Revolution and the Stock Market Jeremy Greenwood and Boyan Jovanic AER 1999

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**The Information-Technology Revolution and the Stock**MarketJeremy Greenwood and Boyan JovanicAER 1999**A simple model (a la Lucas 1978)**Simple exchange economy: many infinitely lived agents, and equally many “trees”, each tree yielding a “dividend” (output that goes to the owner) of dt at each period t. The (stock market) price of a tree at time zero:**Lucas model – cont.**Notice that P0 is also the ratio: stock market value/output (S/GDP) since output=1.**An (expected) tech shock**News arrive at t=0 that a fraction x of existing trees will die at date T, and will be replaced by equally many better trees, yielding an output of 1+z. Thus output from T on will be: Output over time is therefore, The new trees will not trade in the stock market until they actually appear at T.**Two types of trees traded in the stock market, before T**Type-1 tree – dies at T, liquidation value of zero; before T its price is, Type-2 tree – lives forever. It stock market value:**Type-2 trees**Define,**Stock market value before T**Recall that, Hence if x goes up, overall market value goes down.**Stock market value: comparative statics (for t<T)**• Ptdecreases with x: • more trees are expected to be replaced by trees that are not yet in the market (type 1); • higher x increases consumption in the future, hence lowering U’: alpha down, P2 down. • Pt decreases with z: same as (ii) • Pt increases with T: longer life of present trees, thus their (present) value goes up (recall beta<1, hence if T goes to infinity, max value).**Stock market value afterT**At date T new trees pop up and start to be traded. Output per tree, hence also consumption and dividends rise permanently to (1 + xz). Hence,**Stock Market Value to GDP Ratio from GPT HT model**S falls faster than GDP in phase 1, but starts recovering before phase 2**Comments on S/GDP**• Big innovations may at first (and for quite a while) reduce overall Stock Market Value: the appearance of the new GPT means that the old one will soon be obsolete, and these are bad news! • In the GJ model cannot trade in the new “trees” • In HT can trade but the new firms are making zero profits; the old firms have constant profits over the first phase, but their horizon is shrinking!**1968 Incumbents (“old trees”) vs. all firms**“old tree” firms**The rise of Nadaq firms**The 1968 incumbents did badly, entrants did very well ~ 20 years later**Winners and Losers in IT**IBM, Burroughs, Honeywell, NCR, Sperry Rand, DEC, Data General Apple, Compaq, Dell, Gateway, Microsoft, Novel, Oracle, AOL, Yahoo, etc.

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