Share Prices and Investment

Abstract

In this paper we examine two related propositions: the efficiency of pricing of Australian shares and the influences of share prices on business investment. In line with similar studies overseas, we find that the Australian share market may deviate from efficient pricing over short time horizons but that there is little evidence of inefficiency over longer time horizons. To investigate the influence of share prices on investment decisions we use a simple model of real share prices to identify estimates of the ‘fundamental’ and ‘speculative’ components of share prices. As expected, the estimated fundamental component of real share prices is found to have a stronger relationship with investment than the aggregate real share price series. Despite some evidence of share price inefficiences, the speculative component of real share prices is insignificant in the same investment equations, providing evidence that speculative movements in share prices do not have a significant effect on business investment. There is evidence, however, that these speculative share price movements influence the composition of corporate financing. In particular, the timing of equity raisings appears to be influenced by both components of share prices.

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