TY  - JOUR
AU  - Angeletos,George-Marios
AU  - Lorenzoni,Guido
AU  - Pavan,Alessandro
TI  - Wall Street and Silicon Valley:  A Delicate Interaction
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 13475
PY  - 2007
Y2  - October 2007
UR  - http://www.nber.org/papers/w13475
L1  - http://www.nber.org/papers/w13475.pdf
N1  - Author contact info:
George-Marios Angeletos
Department of Economics
MIT E52-251
50 Memorial Drive
Cambridge, MA  02142-1347
Tel: 617/452-3859
Fax: 617/253-1330
E-Mail: angelet@mit.edu

Guido Lorenzoni
MIT Department of Economics
E52-251C
50 Memorial Drive
Cambridge, MA 02142-1347
Tel: 617/253-4836
Fax: 617/253-1330
E-Mail: glorenzo@mit.edu

Alessandro Pavan
Northwestern University
Department of Economics
2001 Sheridan Road
Arthur Andersen Hall 3239
Evanston, IL 60208
E-Mail: alepavan@northwestern.edu
AB  - 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.
ER  -