1 Are Positive Feedback Investors Successful in Creating Bubbles at the Expense of Rational Traders?: How Foreign Investors Created the Nokia Bubble and Profited from It*

We test predictions from a variety of stock price ‘bubble ’ models during the Nokia bubble period in Finland using data identifying the daily trades of every participant. Largely driven by Nokia, the Finnish Stock Market Index rose 192.1 % between January 1997 and March 2000 and then fell by 56.1 % during the Hi-Tech correction period to March 2003. We also examine the bubble leading up to the Global Financial Crisis and subsequent collapse. For the 16 top Finnish stocks, the daily order imbalances (price pressure) of foreign institutional investors adopting positive feedback trading strategies significantly drove up the market to book ratio of these stocks during both bubble periods while mainly contrarian households exerted pressure in the opposite direction via significant negative order imbalances. Foreign investor order imbalances seem to have distorted stock prices well away from fundamentals and their ability to distort prices actually generated trading profits at the expense of domestic institutional traders. Contrary to the belief that individuals are unsophisticated, contrarian household investors do exceedingly well over the entire Hi-Tech bubble cycle earning realized returns of 45 % (foreigners, 1.1%) and unrealized, 56 % (foreigners 1.1%)