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Wall Street and Silicon Valley: A Delicate Interaction

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  • George-Marios Angeletos
  • Guido Lorenzoni
  • Alessandro Pavan

Abstract

Financial markets look at data on aggregate investment for clues about underlying profitability. At the same time, firms' investment depends on expected equity prices. This generates a two-way feedback between financial market prices and investment. In this paper we study the positive and normative implications of this interaction during episodes of intense technological change, when information about new investment opportunities is highly dispersed. Because high aggregate investment is "good news" for profitability, asset prices increase with aggregate investment. Because firms' incentives to invest in turn increase with asset prices, an endogenous complementarity emerges in investment decisions -- a complementarity that is due purely to informational reasons. We show that this complementarity dampens the impact of fundamentals (shifts in underlying profitability) and amplifies the impact of noise (correlated errors in individual assessments of profitability). We next show that these effects are symptoms of inefficiency: equilibrium investment reacts too little to fundamentals and too much to noise. We finally discuss policies that improve efficiency without requiring any informational advantage on the government's side.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13475.

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Date of creation: Oct 2007
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Handle: RePEc:nbr:nberwo:13475

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Citations

Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. “Wall Street and Silicon Valley: A Delicate Interaction,” G.-M. Angeletos, G. Lorenzoni & A. Pavan (2012)
    by afinetheorem in A Fine Theorem on 2014-03-06 11:22:41
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Cited by:
  1. Gabriel Desgranges & Céline Rochon, 2013. "Conformism and public news," Economic Theory, Springer, vol. 52(3), pages 1061-1090, April.
  2. Tarek A. Hassan & Thomas M. Mertens, 2011. "The Social Cost of Near-Rational Investment," NBER Working Papers 17027, National Bureau of Economic Research, Inc.
  3. George-Marios Angeletos & Guido Lorenzoni & Alessandro Pavan, 2010. "Beauty Contests and Irrational Exuberance: A Neoclassical Approach," NBER Working Papers 15883, National Bureau of Economic Research, Inc.
  4. Kathy Yuan & Emre Ozdenoren & Itay Goldstein, 2008. "Learning and Complementarities: Implications for Speculative Attacks," 2008 Meeting Papers 276, Society for Economic Dynamics.
  5. George-Marios Angeletos & Alessandro Pavan, 2007. "Policy with Dispersed Information," NBER Working Papers 13590, National Bureau of Economic Research, Inc.
  6. Kevin J. Lansing, 2008. "Speculative growth and overreaction to technology shocks," Working Paper Series 2008-08, Federal Reserve Bank of San Francisco.
  7. Gabriel Desgranges & Céline Rochon, 2008. "Conformism, Public News and Market Efficiency," THEMA Working Papers 2008-24, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  8. George-Marios Angeletos & Jennifer La'O, 2009. "Incomplete Information, Higher-Order Beliefs and Price Inertia," NBER Working Papers 15003, National Bureau of Economic Research, Inc.
  9. Kathy Yuan & Emre Ozdenoren & Itay Goldstein, 2010. "Trading Frenzies and Their Impact on Real Investment," 2010 Meeting Papers 94, Society for Economic Dynamics.
  10. Dmitry Shapiro & Xianwen Shi & Artie Zillante, 2009. "Robustness of Level-k Reasoning in Generalized Beauty Contest Games," Working Papers tecipa-380, University of Toronto, Department of Economics.
  11. Tarek Alexander Hassan & Thomas Mertens, 2014. "Information Aggregation in a DSGE Model," NBER Chapters, in: NBER Macroeconomics Annual 2014, Volume 29 National Bureau of Economic Research, Inc.
  12. Péter Kondor, 2009. "The more we know, the less we agree: Higher-order expectations and public announcements," 2009 Meeting Papers 1018, Society for Economic Dynamics.

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