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Optimal Learning, Overvaluation and Overinvestment

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  • Barbosa, António

Abstract

Periods of technological revolution are usually associated with overvaluation of and overinvestment by innovating firms. This paper develops a model that explains this behavior in a frictionless rational setting. When fully rational innovating firms face uncertainty about the returns to scale of their production functions, overinvestment emerges as the optimal way to learn about the returns to scale. The optimal learning is also shown to produce overvaluation. The model is also able to generate what an observer ex-post would identify as bubbles followed by overcorrection, negative excess returns in early periods, negative autocorrelation in excess returns and market-to-book and size effects.

Suggested Citation

  • Barbosa, António, 2019. "Optimal Learning, Overvaluation and Overinvestment," MPRA Paper 97411, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:97411
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    File URL: https://mpra.ub.uni-muenchen.de/97411/1/MPRA_paper_97411.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Learning; Investment Decision; Bubbles;
    All these keywords.

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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