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Darla Moore School of Business

Moore School expert explains the GameStop market shock

This week, web sleuths on user-contributed website Reddit managed to upend the stock market by driving the price of video game store GameStop’s stock to unprecedented levels. The impact is multi-faceted, including causing a major hedge fund institutional investor to declare bankruptcy. Moore School Finance Assistant Professor Chao Jiang’s research focuses on factors affecting stock returns, and he has been keeping a close eye on the GameStop phenomenon.

How has the GameStop situation occurring on Wall Street affected the overall stock market?

The immediate impact of GameStop’s trading frenzy on the overall market is not clear and is likely to be limited if it will have any impact at all because GameStop is not a huge company with a significant stake in the stock market. However, it can affect regulation. An asset bubble, a stock’s dramatic rise in price over such a short period not supported by the value of the product, is costly, so regulators may make legislative changes to prevent such episodes from happening in the future.

Besides GameStop’s irrational stock price, policy makers may also look into the controversy of brokerage firms limiting trading of this and other stocks. There are already debates on whether it is legal for online brokerage firms like Robinhood and Interactive Brokers to restrict trading in certain stocks. A system-wide rule similar to a trade curb or circuit breaker might be helpful. (A trade curb is a financial regulatory procedure in place to prevent stock market crashes; a circuit breaker is a temporary measure that stops trading to prevent panic-selling.)

What is the lesson to be learned from this situation?

Investors can be irrational. Unfortunately, the GameStop frenzy is unlikely to prevent the next trading mania from happening. The phenomenon of a stock’s dramatic rise in price over such a short period not supported by the value of the product has happened over and over again throughout history.

Examples of these asset bubbles in the U.S. include the dotcom bubble in the late 1990s and the housing bubble in the mid-2000s. With the mindset of “this time is different,” episodes of trading frenzy or asset bubbles are likely to continue to happen in the future.

In addition, individual investors are often discounted with regard to their role in setting prices. This incident highlights that wide access to brokerage apps together with social media can significantly change the way information is incorporated into prices.

Any other thoughts about this GameStop “takeover” by amateurs?

Unlike asset bubbles in the past in which investors only focus on profit, according to some social media, the GameStop situation is a war between amateurs and short-sellers, who profit from stock price drops when business owners and other shareholders suffer losses.

There seems to be some misunderstanding from the public. Short-sellers are an important part of the ecosystem for a healthy stock market because they usually push an overpriced stock to its fundamental value. When short-selling is banned, there are likely more mis-priced stocks. Business owners and other shareholders will not benefit when every stock in the market is like GameStop.   

According to social media, the GameStop situation is also a battle between “working class” and “Wall Street,” little guys” and “big guys,” “the poor” and “the rich,” and “the 99 percent” and “the 1 percent.” It is the “Occupy Wall Street 2.0.” I think this battle may reflect frustrations due to mistrust towards the regulatory system and, more fundamentally, income inequality.

In addition, the GameStop takeover shows the impact of social media on the investment world. It has become a platform for individual investors to form collective and systematic decisions. Consequently, it has profound implications for executives, retail and professional investors, as well as regulators.

*Jiang said his colleague John Hackney, a fellow Moore School finance assistant professor, contributed to the information he provided.

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