Investment Based Valuation and Managerial Expectations

Abstract

A generalized version of the standard neoclassical investment model can explain the relatively high equity prices in the late 1990s and early 2000s in the US corporate nonfinancial and NASDAQ sectors along with the relatively low prices before and after this period. Stock returns predicted by the model are as volatile as the observed stock returns in both sectors. Three key model assumptions are multiple capital goods, investment-specific technological change and non-quadratic adjustment costs. During the "bubble" period, investment in equipment is relatively high - consistent with high expected cash flows and high prices. Investment rates subsequently fall - consistent with lower expected cash flows and lower prices. On average, managers' forecasts are correct. Levels and changes in managerial expectations are correlated with proxies for investor sentiment. Increases in the growth rate of equipment investment coincide with decreases in measured productivity growth. This is consistent with the unobserved diversion of labor from producing output towards accumulating human capital or other intangible assets.

Keywords: Neoclassical, production based asset pricing, investment specific technological change, investment based asset pricing, high-tech bubble, rational, human capital, structures, equipment, adjustment costs, valuation, intangible assets, bubble, asset pricing, sentiment, expectations, nasdaq

JEL Classification: E13, G12, E22