What is being modelled and what is the modelling framework ?

1. A Discussion by Alan Kirman of « Information Aggregation and InvestmentDecisions »Elias Albagli, Christian Hellwig and AlehTsyvinski

2. Whatisbeingmodelled and whatis the modellingframework? • The authors look at the price of a firm’sshares and how information about the firmisintegratedintothatprice. • The firm’ssharepriceisrelated to the firm’sinvestmentdecisions. Managers get information fromtheirshareprice. • Given the assumptions the sharepriceexceeds the expected value of dividends. • Not only a relation but a predictable one!

3. Olderdoubts • Whenotherdeterminants of investmentare controlledfor, shareprices do not seem to explainmuch of the variation in investment in any of the G7 countries. • For some countries, thereisevidencethat an estimate of thecomponent of shareprices not related to available information iscorrelatedwithinvestment to a statisticallysignificantdegree. However, the magnitude of thisrelationshipistoosmall to bemeaningfuleconomically, and the design of the tests are biasedtowardssucha finding. Tease OECD 1993

4. Somerecentevidence • « wefindstrong positive correlationbetween the amount of private information in price and the investment-to-pricesensitivity. This relation isrobust to the inclusion of controls for managerial information, analystcoverage, capital constraint, and firm size, as well as to a variety of differentspecifications. • Overall, ourresults are consistent with the hypothesisthatsome information in priceis new to managers and that managers learnitfrom the price and incorporateit in theirinvestmentdecisions.Thepossibilitythatprices guide managers in theirinvestmentdecisionsimpliesthatfinancialmarkets affect the real economy. » • Chen et al. (2007) The Review of Financial Studies

5. Who has information about what? • The « fundamental » value q of the firmisdrawnfrom a normal distribution • There is a « demandshock » • The continuum of shareholderseachhold one share and receive a signal whichisdrawnfrom a normal distribution withmeanq • Theydecidewhether to holdtheirshare or to sell and the marketisequilibrated by setting theirsupplyequal to the uninformeddemandwhichisrationalisedlater in the paper.

6. A first question • Whatis happening hereisthat information fromthoseoutside the firmwhich the manager does not have isgettingincorporatedinto the signal. • Althoughthis basic ideaisjustified in a number of recentpapers (knowledge about demand or rival products) how realisticisit to assume that the large number of shareholders all receiveindependentsignals about the fundamentals? • This recalls the comment by Poincaré on Bachelier’sthesis

7. A warning • Quand des hommes sont rapprochés, ils ne se décident plus au hasard et indépendamment les uns des autres ; ils réagissent les uns sur les autres. Des causes multiples entrent en action, et elles troublent les hommes, les entraînent à droite et à gauche, mais il y a une chose qu'elles ne peuvent détruire, ce sont leurs habitudes de moutons de Panurge. Et c'est cela qui se conserve Henri Poincaré Report on Bachelier’s Ph D thesis 1900

8. This raisesfurther questions • Althoughthisis a market for the shares of one firmthey are beingsold on a marketwhichiscleared by an auctioneer, thus the mechanism and timing of decisionsis not takenintoaccountwhereasshares are nowtradedthrough a CDA in whichthereiscontinuousupdating of the price as a result of the trades of the individuals. • Isn’tthere a discrepancybetween the time for the forming of supply and that for investmentdecisions?

9. Twokeyfeatures • First the pricefunction must beinvertible for all of this to work • The ideaisthat the marginal trader has to have an increasingexpecteddividend to makehimwilling to pay a higherprice. • This convexitywillproduce the wedgebetween V(z) and P(z)

10. Two questions • Whathappensnext time? Shares have now been transferred to new people. • Who are they and how willtheynowbehave? • Whatwouldhappen if the actors in this story read the paper?