“Aggregate Investment and Stock Returns”

ByF.Duarte , L. Kogan and D. Livdan

Discussion

By

D.P.Tsomocos

3rd International Moscow Finance Conference

November 8-9,2013

Moscow

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Summary I

• A canonical real business cycle model with preference shocks to the representative household

− time varying beliefs w.r.t. pessimism or optimism (cf habit formation)

→ variation of risk prices

• Inverse relation between investment and future excess returns

− lower discount rates → higher NPVs of investments → increased aggrregatet investment

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Summary II

• Positive relation between investment and future stock market volatility

− Elementary stock valuation implies that lower discount rates for given dividend rules increase equity prices. The lower the difference between discount and growth rates the higher the impact on prices.

− since lower discount rates lead to higher investment → time varying discount rates generate positively related investment and stock market volatility.

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Summary III

• A general equilibrium formulation of a stock market negative mean-variance trade off, ceteris paribus, generated by time varying discount rates.

• Perturbations of production functions and preferences determine the variability of discount rates.

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Comments I

•Real changes cause real effects → emphasis on prices rather than on quantities:

→ Δ M • V = Δ P • Q̅,

•Debreu-Mantel-Sonnenshein Theorem: − “Any aggregate excess demand can be generated by

a reasonable economy”.

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Comments II

•Incomplete asset markets

−Precautionary motive causes higher equity premia (Weil, 1982)

•Liquidity constraints and premia

−Liquidity shortages generate higher state prices and, thus, decrease investment (Goodhart, Espinoza and Tsomocos, 2009)

•Modigliani-Miller − Endogenous default and limited liability (Kashyap, Tsomocos and Vardoulakis, 2013)

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THANK YOU!