Fundamentals, Misvaluation, and Business Investment

Does stock market misvaluation affect business fixed investment? To answer this question, we provide evidence based on U.S. firm-level panel data. We examine the orthogonality conditions for the investment Q and Euler equations, and our qualitative tests reject the null hypothesis that investment is unaffected by misvaluation (this result is not driven exclusively by the late 1990s). To measure the quantitative effects on investment, we introduce a measure of misvaluation into standard investment equations. Our estimates imply that a one-standard-deviation increase in misvaluation increases investment between 20% and 60% relative to the mean level of investment in the sample.