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Commitment to Overinvest and Price Informativeness

Author

Listed:
  • Alexander Guembel
  • James Dow
  • London Business School
  • Itay Goldstein
  • Wharton School
  • University of Pennsylvaniaor|1|paper_authors_othe

Abstract

A fundamental role of financial markets is to gather information on firms` investment opportunities, and so help guide investment decisions in the real sector. We argue in this paper that firms` overinvestment is something necessary to induce speculators in financial markets to produce information. If firms always cancel planned investments following poor stock market response, the value of their shares will become insensitive to information on investment opportunities, so that speculators will be deterred from producing information. We discuss several commitment devices firms can use to facilitate information production. We show that the mechanism studied in the paper amplifies shocks to fundamentals across stages of the business cycle.

Suggested Citation

  • Alexander Guembel & James Dow & London Business School & Itay Goldstein & Wharton School & University of Pennsylvaniaor|1|paper_authors_othe, 2005. "Commitment to Overinvest and Price Informativeness," Economics Series Working Papers 2005-FE-18, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:2005-fe-18
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    Cited by:

    1. Bond, Philip & Eraslan, Hülya, 2010. "Information-based trade," Journal of Economic Theory, Elsevier, vol. 145(5), pages 1675-1703, September.
    2. Philip Bond & Hulya Eraslan, 2007. "Information-based trade," Levine's Bibliography 122247000000001689, UCLA Department of Economics.
    3. Philip Bond & Itay Goldstein & Edward Simpson Prescott, 2006. "Market-based regulation and the informational content of prices," Working Paper 06-12, Federal Reserve Bank of Richmond.

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