Do Bubbles Lead to Overinvestment?: A Revealed Preference Approach

Many economists believe that the stock market plays an important role in efficiently allocating capital to its most productive uses. This standard story of the stock market was called into question by events in the late 1990s, when some observers believed that stock market overvaluation – or a bubble - led to overinvestment. Both the standard and overinvestment stories involve discount rates and, to differentiate between the two stories, this paper examines the discount rates used by firms in making their investment decisions.We use a revealed preference approach that relies on the pattern of investment spending – combined with investment theory – to estimate the discount rates used by managers. The standard story predicts that firms with high stock prices and good investment opportunities should have discount rates that do not differ systematically from the risk-adjusted market rate. The overinvestment story predicts that firms with high stock prices and poor investment opportunities should have discount rates consistently below the market rate.Based on a panel dataset of over 50,000 firm-year observations, we find support for both stories. The behavior of high stock price firms with good measured investment opportunities is best described by the standard story, while the overinvestment story provides the most appropriate interpretation of the behavior of high stock price firms with poor investment opportunities. Firms in this latter category accumulate between 15.1% and 45.2% too much capital. These estimates suggest that, even before they burst, bubbles adversely affect economic activity by misallocating capital.bubbles, investment, stock markets, real effects of financial markets, capital formation

The Irreversibility Premium

When investment is irreversible, theory suggests that firms will be “reluctant to invest.” This reluctance creates a wedge between the discount rate guiding investment decisions and the standard Jorgensonian user cost (adjusted for risk). We use the intertemporal tradeoff between the benefits and costs of changing the capital stock to estimate this wedge, which we label the irreversibility premium. Estimates are based on panel data for the period 1980-2001. The large dataset allows us to estimate the effects of limited resale markets, low depreciation rates, high uncertainty, and negative industry-wide shocks on the irreversibility premium. Our estimates provide a readily interpretable measure of the importance of irreversibility and document that the irreversibility premium is both economically and statistically significant.irreversibility, investment, non-convex adjustment costs

Fundamentals, Misvaluation, and Investment: The Real Story

Is real investment fully determined by fundamentals or is it sometimes affected by stock market misvaluation? We introduce three new tests that: measure the reaction of investment to sales shocks for firms that may be overvalued; use Fama-MacBeth regressions to determine whether "overinvestment" affects subsequent returns; and analyze the time path of the marginal product of capital in reaction to fundamental and misvaluation shocks. Besides these qualitative tests, we introduce a measure of misvaluation into standard investment equations to estimate the quantitative effect of misvaluation on investment. Overall, the evidence suggests that both fundamental and misvaluation shocks affect investment.investment, stock market, fundamentals, misvaluation, bubbles, real effects of financial markets

A Revealed Preference Approach. To Understanding Corporate Governance Problems: Evidence From Canada

Empire-building by managers implies that they use a lower effective discount rate in making investment decisions. We use actual investment decisions to measure the gap between the manager’s effective discount rate and the market rate. Our empirical work is based on panel data for 193 Canadian firms. Distinctive institutional features, such as interrelated groups of Canadian firms and concentrated share ownership, allow us to quantify the sensitivity of effective discount rates and governance problems to these institutional control mechanisms. For the firms most likely to be affected by the agency problems highlighted by Jensen (1986), estimated discount rates are 350-400 basis points less than the market rate, supporting the Free Cash Flow view that unresolved corporate governance problems distort firm behavior. Firms in our sample that face Free Cash Flow problems have a stock of fixed capital approximately 7% to 22% higher than would prevail under value maximizing behavior.Corporate governance, Business investment, Discount rates

Fundamentals, Misvaluation, and Investment. The Real Story

Is real investment fully determined by fundamentals or is it sometimes affected by stockmarket misvaluation? We introduce three new tests that: measure the reaction of investment to sales shocks for firms that may be overvalued; use Fama-MacBeth regressions to determine whether "overinvestment" affects subsequent returns; and analyze the time path of the marginal product of capital in reaction to fundamental and misvaluation shocks. Besides these qualitative tests, we introduce a measure of misvaluation into standard investment equations to estimate the quantitative effect of misvaluation on investment. Overall, the evidence suggests that both fundamental and misvaluation shocks affect investment.Investment, Stock market, Fundamentals, Misvaluation, Bubbles, Real effects of financial markets

Do bubbles lead to overinvestment? A revealed preference approach

Many economists believe that the stock market plays an important role in efficiently allocating capital to its most productive uses. This standard story of the stock market was called into question by events in the late 1990s, when some observers believed that stock market overvaluation - or a bubble - led to overinvestment. Both the standard and overinvestment stories involve discount rates and, to differentiate between the two stories, this paper examines the discount rates used by firms in making their investment decisions. We use a revealed preference approach that relies on the pattern of investment spending - combined with investment theory - to estimate the discount rates used by managers. The standard story predicts that firms with high stock prices and good investment opportunities should have discount rates that do not differ systematically from the risk-adjusted market rate. The overinvestment story predicts that firms with high stock prices and poor investment opportunities should have discount rates consistently below the market rate. Based on a panel dataset of over 50,000 firm-year observations, we find support for both stories. The behavior of high stock price firms with good measured investment opportunities is best described by the standard story, while the overinvestment story provides the most appropriate interpretation of the behavior of high stock price firms with poor investment opportunities. Firms in this latter category accumulate between 15.1% and 45.2% too much capital. These estimates suggest that, even before they burst, bubbles adversely affect economic activity by misallocating capital

The irreversibility premium

When investment is irreversible, theory suggests that firms will be reluctant to invest. This reluctance creates a wedge between the discount rate guiding investment decisions and the standard Jorgensonian user cost (adjusted for risk). We use the intertemporal tradeoff between the benefits and costs of changing the capital stock to estimate this wedge, which we label the irreversibility premium. Estimates are based on panel data for the period 1980-2001. The large dataset allows us to estimate the effects of limited resale markets, low depreciation rates, high uncertainty, and negative industry-wide shocks on the irreversibility premium. Our estimates provide a readily interpretable measure of the importance of irreversibility and document that the irreversibility premium is both economically and statistically significant

Temperature scaling in a dense vibro-fluidised granular material

The leading order "temperature" of a dense two dimensional granular material fluidised by external vibrations is determined. An asymptotic solution is obtained where the particles are considered to be elastic in the leading approximation. The velocity distribution is a Maxwell-Boltzmann distribution in the leading approximation. The density profile is determined by solving the momentum balance equation in the vertical direction, where the relation between the pressure and density is provided by the virial equation of state. The predictions of the present analysis show good agreement with simulation results at higher densities where theories for a dilute vibrated granular material, with the pressure-density relation provided by the ideal gas law, are in error. The theory also predicts the scaling relations of the total dissipation in the bed reported by McNamara and Luding (PRE v 58, p 813).Comment: ReVTeX (psfrag), 5 pages, 5 figures, Submitted to PR

Ambipolar Nernst effect in NbSe2_2

The first study of Nernst effect in NbSe$_2$ reveals a large quasi-particle contribution with a magnitude comparable and a sign opposite to the vortex signal. Comparing the effect of the Charge Density Wave(CDW) transition on Hall and Nernst coefficients, we argue that this large Nernst signal originates from the thermally-induced counterflow of electrons and holes and indicates a drastic change in the electron scattering rate in the CDW state. The results provide new input for the debate on the origin of the anomalous Nernst signal in high-T$_c$ cuprates.Comment: 5 pages including 4 figure

A Study of Degenerate Four-quark states in SU(2) Lattice Monte Carlo

The energies of four-quark states are calculated for geometries in which the quarks are situated on the corners of a series of tetrahedra and also for geometries that correspond to gradually distorting these tetrahedra into a plane. The interest in tetrahedra arises because they are composed of {\bf three } degenerate partitions of the four quarks into two two-quark colour singlets. This is an extension of earlier work showing that geometries with {\bf two} degenerate partitions (e.g.\ squares) experience a large binding energy. It is now found that even larger binding energies do not result, but that for the tetrahedra the ground and first excited states become degenerate in energy. The calculation is carried out using SU(2) for static quarks in the quenched approximation with $\beta=2.4$ on a $16^3\times 32$ lattice. The results are analysed using the correlation matrix between different euclidean times and the implications of these results are discussed for a model based on two-quark potentials.Comment: Original Raw PS file replace by a tarred, compressed and uuencoded PS fil