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A Discussion by Alan Kirman of « Information Aggregation and Investment Decisions  » Elias Albagli , Christian Hellwig and Aleh Tsyvinski. What is being modelled and what is the modelling framework ?.

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A Discussion by Alan Kirman of « Information Aggregation and InvestmentDecisions »Elias Albagli, Christian Hellwig and AlehTsyvinski

What is being modelled and what is the modelling framework
Whatisbeingmodelled and whatis the modellingframework?

  • The authors look at the price of a firm’sshares and how information about the firmisintegratedintothatprice.

  • The firm’ssharepriceisrelated to the firm’sinvestmentdecisions. Managers get information fromtheirshareprice.

  • Given the assumptions the sharepriceexceeds the expected value of dividends.

  • Not only a relation but a predictable one!

Older doubts

  • Whenotherdeterminants of investmentare controlledfor, shareprices do not seem to explainmuch of the variation in investment in any of the G7 countries.

  • For some countries, thereisevidencethat an estimate of thecomponent of shareprices not related to available information iscorrelatedwithinvestment to a statisticallysignificantdegree. However, the magnitude of thisrelationshipistoosmall to bemeaningfuleconomically, and the design of the tests are biasedtowardssucha finding. Tease OECD 1993

Some recent evidence

  • « wefindstrong positive correlationbetween the amount of private information in price and the investment-to-pricesensitivity. This relation isrobust to the inclusion of controls for managerial information, analystcoverage, capital constraint, and firm size, as well as to a variety of differentspecifications.

  • Overall, ourresults are consistent with the hypothesisthatsome information in priceis new to managers and that managers learnitfrom the price and incorporateit in theirinvestmentdecisions.Thepossibilitythatprices guide managers in theirinvestmentdecisionsimpliesthatfinancialmarkets affect the real economy. »

  • Chen et al. (2007) The Review of Financial Studies

Who has information about what
Who has information about what?

  • The « fundamental » value q of the firmisdrawnfrom a normal distribution

  • There is a « demandshock »

  • The continuum of shareholderseachhold one share and receive a signal whichisdrawnfrom a normal distribution withmeanq

  • Theydecidewhether to holdtheirshare or to sell and the marketisequilibrated by setting theirsupplyequal to the uninformeddemandwhichisrationalisedlater in the paper.

A first question
A first question

  • Whatis happening hereisthat information fromthoseoutside the firmwhich the manager does not have isgettingincorporatedinto the signal.

  • Althoughthis basic ideaisjustified in a number of recentpapers (knowledge about demand or rival products) how realisticisit to assume that the large number of shareholders all receiveindependentsignals about the fundamentals?

  • This recalls the comment by Poincaré on Bachelier’sthesis

A warning
A warning

  • Quand des hommes sont rapprochés, ils ne se décident plus au hasard et indépendamment les uns des autres ; ils réagissent les uns sur les autres. Des causes multiples entrent en action, et elles troublent les hommes, les entraînent à droite et à gauche, mais il y a une chose qu'elles ne peuvent détruire, ce sont leurs habitudes de moutons de Panurge. Et c'est cela qui se conserve

    Henri Poincaré Report on Bachelier’s Ph D thesis 1900

This raises further questions
This raisesfurther questions

  • Althoughthisis a market for the shares of one firmthey are beingsold on a marketwhichiscleared by an auctioneer, thus the mechanism and timing of decisionsis not takenintoaccountwhereasshares are nowtradedthrough a CDA in whichthereiscontinuousupdating of the price as a result of the trades of the individuals.

  • Isn’tthere a discrepancybetween the time for the forming of supply and that for investmentdecisions?

Two key features

  • First the pricefunction must beinvertible for all of this to work

  • The ideaisthat the marginal trader has to have an increasingexpecteddividend to makehimwilling to pay a higherprice.

  • This convexitywillproduce the wedgebetween V(z) and P(z)

Two questions
Two questions

  • Whathappensnext time? Shares have now been transferred to new people.

  • Who are they and how willtheynowbehave?

  • Whatwouldhappen if the actors in this story read the paper?