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What’s Different About the GameStop Bubble?

Summary:
By conspiring to drive up struggling companies’ stock prices, GameStop investors believe they beat Wall Street at its own game. But there are no clear-cut heroes or villains in this story, just some investors who will be able to weather their losses better than others. CAMBRIDGE – In the last week of January, the price of stock in GameStop – an ailing brick-and-mortar video-game retailer – soared 323% for the week and 1,700% for the month. Nothing happened within the company to drive the increase; its fundamentals remain unchanged. It was a speculative bubble – but with a twist. Multilateral Cooperation for Global Recovery

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By conspiring to drive up struggling companies’ stock prices, GameStop investors believe they beat Wall Street at its own game. But there are no clear-cut heroes or villains in this story, just some investors who will be able to weather their losses better than others.

CAMBRIDGE – In the last week of January, the price of stock in GameStop – an ailing brick-and-mortar video-game retailer – soared 323% for the week and 1,700% for the month. Nothing happened within the company to drive the increase; its fundamentals remain unchanged. It was a speculative bubble – but with a twist.

With any bubble, investors who get in and out at the right moment make a lot of money, while those who get in too late or stay too long suffer large losses. Participating in a speculative bubble is thus like playing roulette in a casino, with the financial-services companies (like Charles Schwab) and retail-investment platforms (like Robinhood) acting as the “house.”

But the GameStop bubble is unusual, because it challenges both of the most common interpretations of financial markets. The first interpretation is that financial markets efficiently allocate capital to enterprises that have strong economic fundamentals and away from those that do not. The second is that big Wall Street traders speculate in ways that destabilize markets, making unseemly profits at the expense of the little guy.

The investors who purchased all those GameStop shares – often young, mostly amateur traders coordinating on message boards such as Reddit’s WallStreetBets – seem to subscribe to the latter interpretation. In their view, by conspiring to drive up struggling companies’ stock prices, the little guy was beating Wall Street at its own game. And, indeed, the hedge funds that had been short-selling GameStop have swallowed massive losses.

But this David-versus-Goliath narrative has serious flaws. In fact, there are no clear-cut heroes or villains in the GameStop story. For starters, both sides used the same tool: options trading. The hedge funds bought put options (“selling short”), betting the stock would fall. The small traders then bought call options (“going long”), betting it would rise. They did the same with other struggling companies, such as the movie-theater chain AMC Entertainment and the mobile-device manufacturer BlackBerry.

Jeffrey Frankel
Jeffrey Frankel, a professor at Harvard University's Kennedy School of Government, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He directs the Program in International Finance and Macroeconomics at the US National Bureau of Economic Research, where he is a member of the Business Cycle Dating Committee, the official US arbiter of recession and recovery.

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