Rational Stock Market Catering
56 Pages Posted: 25 May 2016 Last revised: 25 Jul 2016
Date Written: July 24, 2016
Tests using American data from 1970 to 2015 support the behavioral hypothesis that firms Cater to investor whims. We show that the standard tests cannot distinguish between the behavioral interpretation, and a rational model in which the firm optimally chooses investment, equity issuance, and dividends; while investors optimally choose consumption, equity, and bank account deposits. The rational model shows the importance of two-way financial flows between investors and firms that are generally ignored in the literature. Using booms, sentiment, and behavioral mispricing measures, we construct new tests of behavioral Catering Theory. In all cases that theory is rejected.
Keywords: Investment, Equity Issuance, Dividends, Share Repurchases, Catering
JEL Classification: G31, G32, G35
Suggested Citation: Suggested Citation