Feedback Effects and Asset Prices

45 Pages Posted: 6 Mar 2007 Last revised: 14 Nov 2007

See all articles by Emre Ozdenoren

Emre Ozdenoren

London Business School; Centre for Economic Policy Research (CEPR)

Kathy Yuan

London School of Economics & Political Science (LSE) - Department of Finance

Date Written: June 2007

Abstract

Feedback effects from asset prices to firm cash flows have been empirically documented. This finding raises a question for asset pricing: How are asset prices determined if price affects the fundamental value, which in turn affects the price? In this environment, by buying assets that others are buying, investors ensure high future cash flows for the firm and subsequent high returns for themselves. Hence, investors have an incentive to coordinate, which may generate self-fulfilling beliefs and multiple equilibria. Using insights from global games, we pin down investors' beliefs, analyze equilibrium prices, and find strong feedback leads to higher excess volatility.

Keywords: Feedback effects, coordination, strategic uncertainty, global games, Grossman-Stiglitz, asymmetric information, heterogenous information, multiple equilibria

JEL Classification: G12, E4, C7

Suggested Citation

Ozdenoren, Emre and Yuan, Kathy Zhichao, Feedback Effects and Asset Prices (June 2007). EFA 2007 Ljubljana Meetings Paper, Available at SSRN: https://ssrn.com/abstract=967714 or http://dx.doi.org/10.2139/ssrn.967714

Emre Ozdenoren (Contact Author)

London Business School ( email )

Sussex Place
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London, London NW1 4SA
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Centre for Economic Policy Research (CEPR)

London
United Kingdom

Kathy Zhichao Yuan

London School of Economics & Political Science (LSE) - Department of Finance ( email )

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London, London WC2A 2AE
United Kingdom
+44 (0)20 7955 6407 (Phone)
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HOME PAGE: http://fmg.lse.ac.uk/~kathy

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