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Commitment to Overinvest and Price Informativeness

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Author Info
James Dow
Itay Goldstein
Alexander Guembel

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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 sometimes 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.

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Paper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number 2005fe18.

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Date of creation: 2005
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Handle: RePEc:sbs:wpsefe:2005fe18

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(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. Philip Bond & Hulya Eraslan, 2007. "Information-based trade," Levine's Bibliography 122247000000001689, UCLA Department of Economics. [Downloadable!]
  2. Philip Bond & Itay Goldstein & Edward S. Prescott, 2006. "Market-based regulation and the informational content of prices," Working Paper 06-12, Federal Reserve Bank of Richmond. [Downloadable!]
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