Fundamentals, Misvaluation, and Investment: The Real Story
58 Pages Posted: 27 Feb 2007
Date Written: February 2007
Is real investment fully determined by fundamentals or is it sometimes affected by stock market misvaluation? We introduce three new tests that: measure the reaction of investment to sales shocks for firms that may be overvalued; use Fama-MacBeth regressions to determine whether overinvestment affects subsequent returns; and analyze the time path of the marginal product of capital in reaction to fundamental and misvaluation shocks. Besides these qualitative tests, we introduce a measure of misvaluation into standard investment equations to estimate the quantitative effect of misvaluation on investment. Overall, the evidence suggests that both fundamental and misvaluation shocks affect investment.
Keywords: investment, stock market, fundamentals, misvaluation, bubbles, real effects of financial markets
JEL Classification: E44, E22, E32, G3
Suggested Citation: Suggested Citation