**4. Dot-com bubble and financial crisis of 2007**

This section builds on the concepts introduced in the literature review and gives specific interpretations on the example of the dot-com bubble and the recent financial crisis which started in 2007.

As already mentioned in introduction, the dot-com bubble can be divided into five stages that were initially described [25] and later refined [17]. First, they argue that there has to be a displacement in the market such as an external shock due to a crisis, a liquidity shortage and so on. Then, normally, the government steps in to calm the situation and the central bank provides liquidity to boost the economy so that credit is created and capital is easily available, for instance capital flood. What is then distinct to a bubble and goes beyond a regular upward movement of a cycle is the euphoria which might be triggered by some disruptive innovation [46]. This might be personal computers, the internet, the internet of things, digital currencies or any other sort of hype. After that, insiders or people close to this industry start to see its limits and begin to sell their stakes—this is when the financial distress occurs. If their sell reaches a critical mass, the bubble crashes and the initial euphoria turns into revulsion so that banks turn cautious to the credits they provide.

#### **4.1. Displacement**

Since markets are interconnected as for example confirmed by the study [45], a holistic perspective for comparison is employed. In this regard the industry under consideration must be specified. For this paper, it is the technology sector which is analysed and even though most of the researchers agree that the dot-com bubble occurred in that sector, others have also identified spillover effects into other sectors such as financial, general industrial and non-cyclical

To tackle the research question, first, a combination of macro-economic indicators was used to compare the dot-com bubble with the recent financial crisis. On the one hand, a global perspective is pursued, but on the other hand, data on an aggregate level was not always available. Therefore, the United States, Germany and China are chosen by their economic dominance and highest nominal gross domestic product as representatives in the named regions to base the local economic indicators on. This way a top-down complementary approach from broad regional equity indices to country specific indicators and indices was employed throughout the paper. The term regional in this regard refers to the regions of North America, Europe and Asia, while local refers to the United States,

Additionally, but due to the limited scope of the paper and the main focus being set on the overall economic situation, a rather simple but meaningful test was employed, the Welch-Satterthwaite t-test. This test in the context of this paper is focused on the comparison of means of returns of two samples. With respect to the regular t-test, the Welch-Satterthwaite t-test gives the advantage of yielding accurate results despite unequal variances of the samples. It is, however, important to strictly differentiate the time-period, index and sector under

So after an overall evaluation of the economic situation, a distinction is done by the comparison of means of returns between the Nasdaq Composite index and the Datastream technology index in the 1990s of the twentieth century for three phases of the bubble – pre-bubble, inflation and crash. For this purpose, assumptions about the timing of the phases had to be made. The pre-bubble period was chosen to start in December 1990, which marked the lowest point of the Nasdaq Composite index in the nineties years of the twentieth century. The bubble inflation period was set to start in November 1998 since this year is based on the academic research [16], while also marking a relative historic low of the index. The peak obviously occurred in March 2000 and marked the transition to the crash-phase. Here the lowest point before the eventual recovery was chosen – October 2002. For the recent years such a clear distinction was not possible and therefore a time-frame as a whole from April 2009 to December

Since the movement of the indices alone cannot support nor reject a bubble, a dedicated section takes into account key performance indicators based on which a fundamental value can

Due to the limited scope of the paper, the influence of business cycles, exchange rates and non-financial factors such as page-views have been of minor coverage in this paper, and hence

2015 was chosen, marking a historic low and high, respectively.

services as well [31].

98 Financial Management from an Emerging Market Perspective

Germany and China.

review.

be estimated.

provide room for further analysis.

In the nineties years of the twentieth century, the breakdown of the Soviet Union and the Japanese Crisis can be identified as two of the major impulses to disrupt the financial world at that time. For the recent financial crisis, it was the bankruptcy of the Lehman Brothers Holdings in September 2008 due to the subprime mortgage crisis. In both cases, the global interconnections of supply chains and markets triggered a spiral of economic decline which is reflected in the respective gross domestic product figures.

#### **4.2. Credit creation**

As a monetary initiative, the central banks in the United States, Europe and China reacted in the same way as the Federal Reserve System during the dot-com bubble, namely decrease lending rates in order to provide liquidity and boost the economy. This time, as basically the whole world is affected, even more capital flows into the market—not just from Japan as during the dot-com bubble. In some cases, the governments were even forced to bail out some banks in order to avoid an economic breakdown of financial systems [47]. Economic research and the central banks confirm the relationship of low interest rates, credit creation and rising prices [48–52]. After these measures, the gross domestic product started to increase and corporate profits recovered too – as seen in **Figure 2**.

Also by other measures such as the unemployment rate and the consumer to business confidence, a recovery with some exceptions was observable. Though these measures worked well for the United States, the issues of the recent financial crisis in the European Union did not allow for a swift and substantial recovery as during the nineties years of the twentieth century in the United States as seen in **Figure 3**.

**Figure 2.** Corporate profit change. Source: own elaboration by the authors.

In the name of the European Central Bank, Mario Draghi promised to further support the economy throughout 2016 and even beyond 2017 if necessary [53]. Putting this promise into perspective and comparing it to the nineties years of the twentieth century, this means that liquidity will flow into the market throughout 2016 and maybe even 2017. Maintaining the interest rate at such low levels, however, increases the risk of a liquidity trap where additional capital in the market does not boost the economy as anticipated due to the neutrality of money in the short-term to long-term [54, 55]. Additionally, current plans to increase the

**Figure 3.** United States output gap. Source: Own elaboration by the authors.

interest rate are damped by the weak support of other indicators. As of 2015, corporate profits stagnate at middle levels and even sharply falling in China in contrast to a steady increase in the middle of the 1990s of the twentieth century in the United States.

#### **4.3. Euphoria**

In the name of the European Central Bank, Mario Draghi promised to further support the economy throughout 2016 and even beyond 2017 if necessary [53]. Putting this promise into perspective and comparing it to the nineties years of the twentieth century, this means that liquidity will flow into the market throughout 2016 and maybe even 2017. Maintaining the interest rate at such low levels, however, increases the risk of a liquidity trap where additional capital in the market does not boost the economy as anticipated due to the neutrality of money in the short-term to long-term [54, 55]. Additionally, current plans to increase the

**Figure 3.** United States output gap. Source: Own elaboration by the authors.

**Figure 2.** Corporate profit change. Source: own elaboration by the authors.

100 Financial Management from an Emerging Market Perspective

Unique during the dot-com bubble was the creation of euphoria through the personal computer and internet technology hype. Today is different in the way that this technology is innovatively utilised rather than completely new. Nevertheless, there are key concepts which are more strongly emphasised by the media than others, such as artificial intelligence, digital currencies, biotechnologies and so on. However, there is no such strong consensus and focus on one particular technology as during the nineties years of the twentieth century. This marks the difference in motivation for investment between those time frames. During the dot-com bubble, several behavioural concepts such as the law of small numbers, herding, self-attribution bias and others were at play [56, 57]. In the recent years, however, the market sentiment was shaped by political uncertainty while the main driver to invest in stocks is the available liquidity fuelled by the tech-start-up spirit. In the scope of this paper, the following stages are unique to the dot-com bubble since as of December 2015 there was no severe downturn of the indices under analysis, for instance a bubble burst.

#### **4.4. Financial distress and revulsion**

All it actually takes to crash a bubble is a critical mass of arbitrageurs who tackle the overvaluation in order for market prices to shift more towards fundamental values. A collapse can happen fundamentally due to the unstable position; the instantaneous cause of the collapse is secondary [58]. The sharp decrease was not triggered by any substantially negative news or announcements. Furthermore, there is an argument that the expiration of a high volume of the lock-up periods expired and provided insiders and arbitrageurs the needed measures to adjust the market and the subsequent fall of the Nasdaq Composite index [36]. More likely it was the interplay and combination of different factors which together created the critical mass that is argued for [59]. Since this critical mass was obviously reached, herding behaviour set in again in the opposite direction—for instance sell—as the news of a downturn spread across media. Eventually, the bubble burst and losses had to be realised which is reflected in most of the indicators shown before, such as the Nasdaq Composite index itself, gross domestic product, corporate profits, the unemployment rate and so on. At this point, banks become more cautious with lending which decreases liquidity in the market and often causes governments and central banks to intervene in order to boost the economy and rebuild trust all over again.
