The puzzle is magnified when we consider what happened to other bio-technology stocks on Monday, May 4, 1998. On average, members of the NASDAQ Biotechnology Combined Index, excluding ENMD, went up by an unusual 7.5 percent on that Monday. The returns of 7 of the stocks in the index exceeded 25 percent on a trading volume that was 50 times the average daily volume (the 7 stocks do not include ENMD). On November 28, 1997, when the breakthrough news actually broke, the average return of the 7 stocks was 4.89 percent on a trading volume comparable to the average daily trading volume at the time.A fundamentals-based approach to stock pricing calls for a price revision when relevant news comes out. Within this framework it is experts who identify the biotechnology companies whose pricing should be most closely tied to do the price revision. These experts follow Nature closely, and therefore the main price reaction of shares of biotechnology firms should have taken place in late November 1997, and not been delayed until May 1998.Our empirical findings are difficult to reconcile with the opening paragraph of this introduction. Stock prices may well be based on the market's expectations of future cash flows. But how are these expectations formed? To what extent do they reflect hard, solid information or spurious publicity? We demonstrate that the latter may be, just as important, and at times even more important, than the former.ENMD provides a very instructive example, although it is merely one firm and the circumstances that we exploit here are unlikely to repeat themselves. This case is interesting because of the magnitude of the price changes, the ability to observe the speed of adjustment, and because the data suggest that the market can both underreact and overreact to announcements.In Section I we describe our data sources, in Section II we report the stock prices of ENMD around the three major event days, in Section III we look at the prices of members of the NASDAQ Biotechnology Combined Index around these days, and concluding remarks are in Section IV.
I. The DataWe use New York Stock Exchange Trade and Quotes (TAQ) for intraday trading data, prices, and quotes and CRSP for daily return data until December 1.997. Some of our 1998 and 1999 data are from CSI, Inc., on Money Central Investor Web Site. Company filings with the SEC provide us with the number of shares outstanding around May 1998 and ownership information. Membership and criteria for membership in the NASDAQ Biotechnology Combined Index are from NASDAQ’s web site.II. Pricing of EntreMed Stock
EntreMed is a small biotechnology company with rights to commercialize a potentially cancer-curing process. Major movements in its stock price occurred on November 28, 1997, May 4, 1998, and November 11, 1998. The November 28, 1997, price increase followed the previous day's publication of a Nature article describing a major breakthrough in the process. On that day, the New York Times and other popular media outlets reported on the Nature article. The May 4, 1998, huge price run up followed a prominent front page article in the Times about the process and the scientists working to develop it. The November 11, 1998, price drop followed that morning's report in the Wall Street Journal that other laboratories had failed to reproduce the original results.