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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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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. Kathy Yuan & Emre Ozdenoren & Itay Goldstein, 2008. "Learning and Complementarities: Implications for Speculative Attacks," 2008 Meeting Papers 276, Society for Economic Dynamics.
  2. Céline Rochon & Gabriel Desgranges, 2011. "Conformism and Public News," IMF Working Papers 11/33, International Monetary Fund.
  3. George-Marios Angeletos & Guido Lorenzoni & Alessandro Pavan, 2010. "Beauty Contests and "Irrational Exuberance": A Neoclassical Approach," Discussion Papers 1502, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. Itay Goldstein & Emre Ozdenoren & Kathy Yuan, 2011. "Trading Frenzies and their Impact on Real Investment," FMG Discussion Papers dp670, Financial Markets Group.
  5. Alessandro Pavan & George-Marios Angeletos, 2008. "Policy with Dispersed Information," 2008 Meeting Papers 1103, Society for Economic Dynamics.
  6. 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.
  7. Tarek A. Hassan & Thomas M. Mertens, 2011. "The Social Cost of Near-Rational Investment," NBER Working Papers 17027, National Bureau of Economic Research, Inc.
  8. 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.
  9. Kevin J. Lansing, 2008. "Speculative growth and overreaction to technology shocks," Working Paper Series 2008-08, Federal Reserve Bank of San Francisco.
  10. 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.

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