Discussion:
"Innovations and Investment Bubbles"
by Kumar and Langberg
Xiaoji Lin
London School of Economics and Political Science and FMG
WFA 2009, San Diego
Xiaoji Lin (LSE)
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06/19/09
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Summary of the Paper
An agency-based equilibrium model to explain investment bubble
Xiaoji Lin (LSE)
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06/19/09
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My Discussion
An interesting paper
Main mechanism needs empirical support.
Xiaoji Lin (LSE)
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06/19/09
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Bubble: Stock Price and Investment Dynamics
Xiaoji Lin (LSE)
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06/19/09
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The Model
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06/19/09
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The Mechansim
1
Over-reporting productivity of a low type …rm
2
! Over investment by a low type …rm
3
! Increase in
4
! Industry over investment along equilibrium path
Xiaoji Lin (LSE)
investor’s conditional expectation of economic conditions
the likelyhood of over-reporting of subsequent …rms
Discussion
06/19/09
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Discussion 1: Entering Firms
Model: it is necessary that the …rst entering …rms are low-type …rms.
But costly adoption implies
adopting …rms should more productive
(Bartel and Lichtenberg 1987, Krusell et al 2000).
Model: over-reporting of low-type …rm has externality on other …rms investment
decision.
Quantitatively, how large the propogation mechansim needs to be?
Xiaoji Lin (LSE)
Discussion
06/19/09
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Discussion 2: Time Varying Discount Rate
Model: optimal level of manipulation positively related with discount rate.
α=
R1
ψ γ ( sh
γ
sl ) γ
2
What if discount rate is time-varying and endogenously determined?
Xiaoji Lin (LSE)
Discussion
06/19/09
8 / 12
A Simple Q Model: Hayashi (1982)
Market value of the …rm
max v (xt , zt , kt ) = e xt +zt kt
kt +1 ,it
it
a it 2
( ) kt + Et [Mt +1 v (xt +1 , zt +1 , kt +1 )]
2 kt
subject to: kt +1 = (1
δ)kt + it
x: aggregate shock; z: …rm-speci…c shock; k: capital; i: investment; Mt +1 :
the pricing kernel
Marginal q
qt = Et
∞
∑ Mt +j
(1
δ )j
1
j =1
a it +j 2
e x t +j +z t +j + (
)
2 kt +j
Discount rate channel
Cochrane (1991), Lettau and Ludvigson (2002), Xing (2008), Liu, Whited
and Zhang (2008)
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06/19/09
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Risk Varies across Bubble Period
What if the bubble period coincide with low discount rate?
Sample
Beta
Systematic Volatility
Pre-bubble (till June 1998)
9.7%
30.2%
Bubble (June 1998–March 2000)
Post-crash (after March 2000)
-7.2%
15.1%
-30.4%
18.7%
Xiaoji Lin (LSE)
Discussion
06/19/09
10 / 12
Discount Rate Channel
Pastor and Veronesi 2008
1
Before adoption, the uncertainty of future productivity is idiosyncratic
2
! low discount rate
3
! large scale adoption through investment generate bubble
4
! risk becomes systematic and high discount rate
5
! low investment.
Xiaoji Lin (LSE)
Discussion
06/19/09
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Conclusions
A new mechansim on the relation between investment bubble and innovations
Concerns:
Distinguish the model mechansim from the discount rate channel
Empirical evidence for the model mechanism is needed
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06/19/09
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