Feedback Effects and Systematic Risk Exposures

90 Pages Posted: 20 Apr 2021 Last revised: 13 Dec 2023

See all articles by Snehal Banerjee

Snehal Banerjee

University of California, San Diego (UCSD) - Rady School of Management

Bradyn M. Breon-Drish

University of California, San Diego (UCSD) - Rady School of Management

Kevin Smith

Stanford University Graduate School of Business

Date Written: June 28, 2021

Abstract

We model the "feedback effect" of a firm's stock price on investment in projects exposed to a systematic risk factor, like climate risk. The stock price reflects information about both the project's cash flows and its discount rate. A cash-flow maximizing manager treats discount rate fluctuations as "noise," but a price maximizing manager interprets such variation as information about the project's NPV. This difference qualitatively changes how investment behavior depends on the project's risk exposure. Moreover, traditional objectives (e.g., cash-flow or price maximization) need not maximize welfare because they do not correctly account for hedging and risk-sharing benefits of investment.

Keywords: feedback effects, welfare, investment efficiency, hedging, market completeness, risk sharing, discount rate

JEL Classification: D82, D84, G12, G14

Suggested Citation

Banerjee, Snehal and Breon-Drish, Bradyn M. and Smith, Kevin, Feedback Effects and Systematic Risk Exposures (June 28, 2021). Available at SSRN: https://ssrn.com/abstract=3825025 or http://dx.doi.org/10.2139/ssrn.3825025

Snehal Banerjee (Contact Author)

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

Bradyn M. Breon-Drish

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

Kevin Smith

Stanford University Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

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