Do Noisy Stock Prices Impede Real Efficiency?

Management Science, Forthcoming

61 Pages Posted: 11 Jul 2018 Last revised: 11 Aug 2019

See all articles by Steven Chong Xiao

Steven Chong Xiao

University of Texas at Dallas - Naveen Jindal School of Management

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

Xiao, Steven Chong, Do Noisy Stock Prices Impede Real Efficiency? (June 1, 2018). Management Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3199126 or http://dx.doi.org/10.2139/ssrn.3199126

Steven Chong Xiao (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

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