Optimal learning and new technology bubbles

Finance, Finance

IFA Working Paper

2002

It is widely believed that there is a fundamental linkage between major technological innovations, speculative fever, and wasteful overinvestment. This paper presents an equilibrium model of investment in a new industry, whose return-to-scale is not known in advance. Overinvestment relative to the full-information case is then optimal as the most efficient way to learn about the new technology. Moreover, the initial overinvestment is accompanied by apparently inflated stock prices and apparently negative expected excess returns in the new industry, which are also fully rational. This suggests a new interpretation of what seem to be stock market driven real bubbles.

Institute of Finance and Accounting, Institute of Finance and Accounting

FIN 372

IFA Working Paper

No