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Noisy Share Prices and the Q Model of Investment

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Author Info
Stephen Bond (Nuffield College)

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Abstract

We consider to what extent the empirical failings of the Q model of investment can be attributed to the assumption that stock market valuations accurately measure the present value of future net distributions to shareholders. We characterise the implications of different types of measurement error in the conventional average Q ratio that can result from the failure of this assumption, and show that plausible forms of measurement error can result in failure to identify the model's structural parameters. To explore this empirically, we use securities analysts' consensus earnings forecasts to construct an alternative measure of average Q, not based on share prices. Using this measure, we find more reasonable estimates of the size of adjustment costs, no significant cash flow effects, and no evidence of non-linearities. Indeed we find that our measure of average Q is a sufficient statistic for investment, and there is no additional information relevant for investment in stock market valuations. These results suggest that there are highly persistent deviations between stock market values and firms' fundamental valuations, and that these deviations are themselves correlated with fundamentals. This is consistent with rational bubble or noise trader models of share prices.

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Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1320.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1320

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Steve Bond & Alexander Klemm & Rain Newton-Smith & Murtaza Syed & Gertjan Vlieghe, 2004. "The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment," IFS Working Papers W04/12, Institute for Fiscal Studies. [Downloadable!]
    Other versions:
  2. Abdul Abiad & Nienke Oomes & Kenichi Ueda, 2004. "The Quality Effect: Does Financial Liberalization Improve the Allocation of Capital?," IMF Working Papers 04/112, International Monetary Fund. [Downloadable!]
  3. Fernando Alexandre & Pedro Bação, 2005. "Monetary policy and asset prices: the investment channel," NIPE Working Papers 3/2005, NIPE - Universidade do Minho. [Downloadable!]
  4. Simon Gilchrist & Charles P. Himmelberg & Gur Huberman, 2004. "Do Stock Price Bubbles Influence Corporate Investment?," NBER Working Papers 10537, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Steve Bond & Michael Devereux & Alexander Klemm, 2005. "Dissecting dividend decisions: some clues about the effects of dividend taxation from recent UK reforms," IFS Working Papers W05/17, Institute for Fiscal Studies. [Downloadable!]
  6. Murillo Campello & John Graham, 2007. "Do Stock Prices Influence Corporate Decisions? Evidence from the Technology Bubble," NBER Working Papers 13640, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. Stephen R. Bond & Jason G. Cummins, 2004. "Uncertainty and investment: an empirical investigation using data on analysts' profits forecasts," Finance and Economics Discussion Series 2004-20, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  8. Jérôme Héricourt & Sandra Poncet, 2007. "FDI and credit constraints : firm level evidence in China," Documents de travail du Centre d'Economie de la Sorbonne bla07009, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne. [Downloadable!]
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  9. Stoneman, Paul, 2001. "Technological Diffusion and the Financial Environment," EIFC - Technology and Finance Working Papers 3, United Nations University, Institute for New Technologies. [Downloadable!]
  10. Wendy Carlin & Andrew Charlton & Colin Mayer, 2008. "Multinational Ownership and Subsidiary Investment," OFRC Working Papers Series 2008fe05, Oxford Financial Research Centre. [Downloadable!]
  11. O. De Jonghe & R. Vander Vennet, 2007. "Competition versus Efficiency: What drives franchise values in European banking?," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 07/491, Ghent University, Faculty of Economics and Business Administration. [Downloadable!]
  12. Pierre Lafourcade, 2004. "Valuation, investment and the pure profit share," Finance and Economics Discussion Series 2004-08, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  13. Guido Lorenzoni & Karl Walentin, 2007. "Financial Frictions, Investment and Tobin's q," NBER Working Papers 13092, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Jason G. Cummins, 2004. "A new approach to the valuation of intangible capital," Finance and Economics Discussion Series 2004-17, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  15. Pierre Lafourcade, 2003. "Asset prices and rents in a GE model with imperfect competition," Finance and Economics Discussion Series 2003-60, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  16. Shaun K. Roache, 2006. "Domestic Investment and the Cost of Capital in the Caribbean," IMF Working Papers 06/152, International Monetary Fund. [Downloadable!]
  17. Paul Mizen & Philip Vermeulen, 2005. "Corporate investment and cash flow sensitivity - what drives the relationship?," Working Paper Series 485, European Central Bank. [Downloadable!]
  18. Shaun K. Roache, 2006. "Domestic Investment and the Cost of Capital in the Caribbean," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 6(3). [Downloadable!] (restricted)
  19. Stephen Bond & Dietmar Harhoff & John Van Reenen, 2003. "Investment, R&D and Financial Constraints in Britain and Germany," CEP Discussion Papers dp0595, Centre for Economic Performance, LSE. [Downloadable!]
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