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Noisy share prices and the Q model of investment

Author

Listed:
  • Stephen Bond

    (Institute for Fiscal Studies and Nuffield College, Oxford)

  • Jason Cummins

    (Institute for Fiscal Studies and Federal Reserve Board)

Abstract

We consider to what extent the empirical failings of the Q model of investment can be attributed to the use of share prices to measure average q. We show that the usual empirical formulation may fail to identify the Q model when stock market valuations deviate from the present value of expected net distributions in ways that are consistent with weak and semi-strong forms of the Efficient Markets Hypothesis. We show that the structural parameters of the Q model can stil be identified in this case using a direct estimate of the firm's fundamental value, and implement this using data on securities analysts' earnings forecasts for a large sample of publicly traded US firms. Our empirical results suggest that stock market valuations deviate significantly from fundamental values. Controlling for this, we find no evidence that the Q model of investment is seriously misspecified.

Suggested Citation

  • Stephen Bond & Jason Cummins, 2001. "Noisy share prices and the Q model of investment," IFS Working Papers W01/22, Institute for Fiscal Studies.
    • Handle: RePEc:ifs:ifsewp:01/22
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity

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