Wall Street and Silicon Valley
Subtitle: a delicate interaction
By: George-Marios Angeletos, Guido Lorenzoni, Alessandro Pavan.
Contributors: Lorenzoni, Guido.; Pavan, Alessandro.; National Bureau of Economic Research.
Series: NBER working paper series -- no. 13475.; Working paper series (National Bureau of Economic Research) -- working paper no. 13475.
Publisher: National Bureau of Economic Research
Published: 2007
Place of publication: Cambridge, Mass
Language: eng
Number of pages: 49
Subjects: Technological innovations -- Economic aspects; Saving and investment -- Econometric models
Description: 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.
Notes: "October 2007"

Includes bibliographical references (p. 46-49).

Also available in PDF from the NBER World Wide Web site (www.nber.org).