Uncertainty, Investor Sentiment, and Innovation

We develop a theory of innovation waves, investor sentiment, and merger activity based on Knightian uncertainty. Uncertainty-averse investors are more optimistic on an innovation when they can make contemporaneous investments in multiple uncertain projects. Innovation waves occur when there is a critical mass of innovative companies, and are characterized by stronger investor sentiment, higher equity valuation, and hot IPO markets. Our approach to investor sentiment is not based on erroneous beliefs disjoint from economic fundamentals, but depends on uncertainty on the fundamentals. Our model can explain sector-specific booms uncorrelated with aggregate economic activity and the overall stock market.

Keywords: Investor Sentiment, Innovation, Ambiguity Aversion, Hot IPO Markets, Mergers

JEL Classification: D81, G34, O31

Suggested Citation: Suggested Citation

Dicks, David L. and Fulghieri, Paolo, Uncertainty, Investor Sentiment, and Innovation (April 20, 2020). Review of Financial Studies, forthcoming, Available at SSRN: https://ssrn.com/abstract=2676854 or http://dx.doi.org/10.2139/ssrn.2676854