The Stock Market, Profit and Investment

50 Pages Posted: 30 May 2001 Last revised: 18 Sep 2022

See all articles by Olivier J. Blanchard

Olivier J. Blanchard

National Bureau of Economic Research (NBER); Peterson Institute for International Economics

Changyong Rhee

Asian Development Bank

Lawrence H. Summers

Harvard University; National Bureau of Economic Research (NBER); Harvard University - Harvard Kennedy School (HKS)

Date Written: May 1990

Abstract

Should managers, when making investment decisions, follow the signals given by the stock market even if those do not coincide with their own assessments of fundamental value? This paper reviews the theoretical arguments and examines the empirical evidence, constructing and using a new US time series of data on the q ratio from 1900 to 1988. We decompose q - - the ratio of the market value of corporate capital to its replacement cost - - into the product of two terms, reflecting "fundamentals" and "valuation", the ratio of market value to fundamentals. We then examine the relation of investment to each of the two, using a number of alternative proxies for fundamentals. We interpret our results as pointing, strongly but not overwhelmingly, to a larger role of "fundamentals" than of "valuation" in investment decisions.

Suggested Citation

Blanchard, Olivier J. and Rhee, Changyong and Summers, Lawrence H., The Stock Market, Profit and Investment (May 1990). NBER Working Paper No. w3370, Available at SSRN: https://ssrn.com/abstract=226674

Olivier J. Blanchard (Contact Author)

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Peterson Institute for International Economics ( email )

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Changyong Rhee

Asian Development Bank ( email )

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Lawrence H. Summers

Harvard University ( email )

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