Abstract

During technological revolutions, stock prices of innovative firms tend to exhibit high volatility and bubble-like patterns, which are often attributed to investor irrationality. We develop a general equilibrium model that rationalizes the observed price patterns. The high volatility results from high uncertainty about the average productivity of a new technology. Investors learn about this productivity before deciding whether to adopt the technology on a large scale. For technologies that are ultimately adopted, the nature of uncertainty changes from idiosyncratic to systematic as the adoption becomes more likely; as a result, stock prices fall after an initial run-up. This 'bubble' in stock prices is observable ex post but unpredictable ex ante, and it is most pronounced for technologies characterized by high uncertainty and fast adoption. We examine stock prices in the early days of American railroads, and find evidence consistent with a large-scale adoption of the railroad technology by the late 1850s.