Capital Flows in Rational Markets

Martin Schmalz and Francesco Franzoni
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Francesco Franzoni: University of Lugano

No 1012, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: We provide a rational model of capital allocation to projects with uncertain exposure to a systematic risk factor. We show that signal-to-noise ratios are highest when the factor realization is close to zero. As a result, investors redirect more resources across projects during these times. This finding resonates with the Schumpeterian intuition that downturns have a cleansing effect on the economy by improving the efficiency of capital allocation. We measure the speed of capital reallocation with the sensitivity of mutual fund flows to performance and find supporting evidence for the model's nonlinear and linear predictions.

Date: 2014
New Economics Papers: this item is included in nep-ppm
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed014:1012

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