Wall Street and Silicon Valley: A Delicate Interaction

George-Marios Angeletos, Guido Lorenzoni, Alessandro Pavan

NBER Working Paper No. 13475
Issued in October 2007
NBER Program(s):Asset Pricing, Corporate Finance, Economic Fluctuations and Growth

Financial markets look at data on aggregate investment for clues about underlying profitability. At the same time, firms' investment depends on expected equity prices. This generates a two-way feedback between financial market prices and investment. In this paper we study the positive and normative implications of this interaction during episodes of intense technological change, when information about new investment opportunities is highly dispersed. Because high aggregate investment is "good news" for profitability, asset prices increase with aggregate investment. Because firms' incentives to invest in turn increase with asset prices, an endogenous complementarity emerges in investment decisions -- a complementarity that is due purely to informational reasons. We show that this complementarity dampens the impact of fundamentals (shifts in underlying profitability) and amplifies the impact of noise (correlated errors in individual assessments of profitability). We next show that these effects are symptoms of inefficiency: equilibrium investment reacts too little to fundamentals and too much to noise. We finally discuss policies that improve efficiency without requiring any informational advantage on the government's side.

download in pdf format
   (446 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w13475

Users who downloaded this paper also downloaded* these:
Angeletos, Lorenzoni, and Pavan w15883 Beauty Contests and Irrational Exuberance: A Neoclassical Approach
Arora, Branstetter, and Drev w16156 Going Soft: How the Rise of Software Based Innovation Led to the Decline of Japan's IT Industry and the Resurgence of Silicon Valley
Fallick, Fleischmann, and Rebitzer w11710 Job Hopping in Silicon Valley: Some Evidence Concerning the Micro-Foundations of a High Technology Cluster
Cai, Todo, and Zhou w13618 Do Multinationals' R&D Activities Stimulate Indigenous Entrepreneurship? Evidence from China's "Silicon Valley"
Angeletos and Pavan w13590 Policy with Dispersed Information
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us