Evan Soltas
Sep 28, 2015

Boom and Bust and Biotech

Biotechnology and pharmaceuticals stock prices have declined about 20 percent in the last week, wiping out hundreds of billions of dollars in market capitalization. That drop is in the wake of popular outrage at the headline-grabbing Martin Shkreli, whose firm acquired the antimalarial drug Daraprim and had planned to raise its price 50-fold, as well as rumblings of a substantive public-policy response to pharmaceutical prices from the Hillary Clinton campaign.

It seems to me this market reaction raises two possibilities.

First, is this decline just the "inevitable" correction (in the sense of Blanchard and Watson's rational bubbles) for five years of strong performance from biotech stocks?

Blanchard and Watson proposed an idea of bubbles in which an asset price rises faster than other asset prices most of the time but has a small chance of falling catastrophically. As crazy as that sounds, it works fine in expected-value terms, relative to other investments, because the two cancel each other out.

There is some evidence for this proposition in the stylized fact that it's been the riskiest, best-performing biotech/pharma stocks which have corrected most sharply. For example, just compare the new-school Valeant, Celgene, Regeneron, and Biogen with the old-school Pfizer, Merck, Novartis, and Eli Lilly.

Alternatively, let's suppose that some of the decline reflects actual changes in the expected future profits of biotech. Shouldn't it be disturbing that a rough draft of a policy proposal to restrict drug prices caused biotech to implode? What does that say about the social value of these biotech innovations?

Not good things, I think. To the extent that price regulations hit firms differentially, they will hit firms most dependent on the high-price business model that regulators find objectionable. The market has just told us that new-school biotech is built around this model.

Intuitively, a good product does not depend on which way the regulatory winds blow. A lot of the new-school biotech firms just proved they absolutely do. That should concern anyone who is hopeful about the future of health.