Research Discussion Paper – RDP 2011-06 Does Equity Mispricing Influence Household and Firm Decisions? Abstract

Qualitative literature on equity price bubbles has often emphasised the effects of mispriced equity on economic decisions. This paper investigates this issue quantitatively using two ideas. The first is that equity mispricing is transitory, and has no long-run effects on economic outcomes. The second is that there exist observables that are correlated with mispricing, but uncorrelated with changes in fundamentals. Estimates of mispricing appear to accord well with periods described as bubble episodes for the US. The effects of these shocks on household decisions are found to be statistically significant.

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