Feedback Effects and Asset Prices
45 Pages Posted: 6 Mar 2007 Last revised: 14 Nov 2007
Date Written: June 2007
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: Suggested Citation