Optimal Learning, Overvaluation and Overinvestment

50 Pages Posted: 16 Dec 2019

See all articles by António M.R.G. Barbosa

António M.R.G. Barbosa

ISCTE-IUL - Instituto Universitário de Lisboa

Date Written: September 30, 2019

Abstract

Periods of technological revolution are usually associated with overvaluation of and over-investment by innovating firms. This paper develops a model that explains this behavior in a frictionless rational setting. When fully rational innovating firms face uncertainty about the returns to scale of their production functions, over-investment emerges as the optimal way to learn about the returns to scale. The optimal learning is also shown to produce overvaluation. The model is also able to generate what an observer ex-post would identify as bubbles followed by over-correction, negative excess returns in early periods, negative auto-correlation in excess returns and market-to-book and size effects.

Keywords: Learning, Investment Decision, Bubbles

JEL Classification: G12, G14, D25, D83

Suggested Citation

Barbosa, António M.R.G., Optimal Learning, Overvaluation and Overinvestment (September 30, 2019). Available at SSRN: https://ssrn.com/abstract=3494959 or http://dx.doi.org/10.2139/ssrn.3494959

António M.R.G. Barbosa (Contact Author)

ISCTE-IUL - Instituto Universitário de Lisboa ( email )

Av. das Forcas Armadas
Lisbon, 1649-026
Portugal
+351 21 790 39 16 (Phone)

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