Uncertainty, Investor Sentiment, and Innovation
Review of Financial Studies, forthcoming
48 Pages Posted: 21 Oct 2015 Last revised: 22 Apr 2020
Date Written: April 20, 2020
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