The Stock Market and Investment: Is the Market a Sideshow?

Posted: 14 Feb 2014

See all articles by Randall Morck

Randall Morck

University of Alberta - Department of Finance and Statistical Analysis; National Bureau of Economic Research (NBER); European Corporate Governence Institute; Asian Bureau of Finance and Economic Research

Andrei Shleifer

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Robert W. Vishny

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Date Written: June 7, 1989

Abstract

Recent events and research findings increasingly suggest that the stock market is not driven solely by news about fundamentals. There seem to be good theoretical as well as empirical reasons to believe that investor sentiment, also referred to as fads and fashions, affects stock prices. By investor sentiment we mean beliefs held by some investors that cannot be rationally justified. Such investors are sometimes referred to as noise traders. To affect prices, these less-than-rational beliefs have to be correlated across noise traders, otherwise trades based on mistaken judgments would cancel out. When investor sentiment affects the demand of enough investors, security prices diverge from fundamental values.

The debates over market efficiency, exciting as they are, would not be important if the stock market did not affect real economic activity. If the stock market were a sideshow, market inefficiencies would merely redistribute wealth between smart investors and noise traders. But if the stock market influences real economic activity, then the investor sentiment that affects stock prices could also indirectly affect real activity.

Suggested Citation

Morck, Randall K. and Shleifer, Andrei and Vishny, Robert W., The Stock Market and Investment: Is the Market a Sideshow? (June 7, 1989). Brookings Papers on Economic Activity, Vol. 21, No. 2, 1990; University of Alberta School of Business Research Paper No. 2013-634. Available at SSRN: https://ssrn.com/abstract=2276193

Randall K. Morck (Contact Author)

University of Alberta - Department of Finance and Statistical Analysis ( email )

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National Bureau of Economic Research (NBER)

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Andrei Shleifer

Harvard University - Department of Economics ( email )

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HOME PAGE: http://www.economics.harvard.edu/~ashleife/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Robert W. Vishny

University of Chicago - Booth School of Business ( email )

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Chicago, IL 60637
United States
312-702-2522 (Phone)
312-702-0118 (Fax)

National Bureau of Economic Research (NBER)

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United States

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