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Noisy share prices and the Q model of investment

  • Steve Bond

    ()

    (Institute for Fiscal Studies and Nuffield College, Oxford)

  • Jason Cummins

We consider to what extent the empirical failings of the Q model of investment can be attributed to the use of share prices to measure average q. We show that the usual empirical formulation may fail to identify the Q model when stock market valuations deviate from the present value of expected net distributions in ways that are consistent with weak and semi-strong forms of the Efficient Markets Hypothesis. We show that the structural parameters of the Q model can stil be identified in this case using a direct estimate of the firm's fundamental value, and implement this using data on securities analysts' earnings forecasts for a large sample of publicly traded US firms. Our empirical results suggest that stock market valuations deviate significantly from fundamental values. Controlling for this, we find no evidence that the Q model of investment is seriously misspecified.

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Paper provided by Institute for Fiscal Studies in its series IFS Working Papers with number W01/22.

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Length: 38 pp
Date of creation: Sep 2001
Date of revision:
Handle: RePEc:ifs:ifsewp:01/22
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