Noisy Stock Prices and Capital Allocation Efficiency

Abstract

We examine the real effects of stock market efficiency by analyzing how noise in stock prices affects the efficiency of capital allocation. Using data from 42 countries and a long time-series, we find that the efficiency of capital allocation across firms (the sensitivity of corporate investment to growth opportunities) and across industries (the elasticity of industry investment to value added) declines with the amount of noise in stock prices. We also find that the effect of noise is incremental to the amount of information in prices and of a similar magnitude, highlighting the importance of secondary market quality.

Keywords: capital allocation, investment-to-Q sensitivity, investment-to-value-added elasticity, informational efficiency

JEL Classification: G14, G15, G31, D92