Do Noisy Stock Prices Impede Real Efficiency?
Management Science, Forthcoming
61 Pages Posted: 11 Jul 2018 Last revised: 11 Aug 2019
Date Written: June 1, 2018
Abstract
Using volatile and correlated liquidity shocks to investors as a source of noise trading, I show that noise in stock prices impedes real efficiency. A one-standard-deviation increase in mutual fund flow-driven volatility pressure leads to a 2.6%--4.0% decline in ROA and a $22.6 million loss in cash flow in the subsequent 2 years. Noise in stock prices does not affect product market demand, but it reduces firms' total factor productivity, profit margin, and performance in R&D and acquisitions. Further evidence suggests that noise in stock prices impedes real efficiency through three plausible channels: distorting firms' investment decisions through misleading price signals, increasing the cost of capital, and reducing the efficacy of equity-based incentive contracts.
Keywords: Noise Trading, Mutual Fund Flow, Real Efficiency, Market Feedback
JEL Classification: D61, G10, G14, G30, G31
Suggested Citation: Suggested Citation