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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page Investment Behavior, Observable Expectations, and Internal Funds
Jason G. Cummins, Kevin A. Hassett, and Stephen D. Oliner

Abstract: We use earnings forecasts from securities analysts to construct more accurate measures of the fundamentals that affect the expected returns to investment. We find that investment responds significantly -- in both economic and statistical terms -- to our new measures of fundamentals. Our estimates imply that the elasticity of the investment-capital ratio with respect to a change in fundamentals is generally greater than unity. In addition, we find that internal funds are uncorrelated with investment spending, even for selected subsamples of firms -- those paying no dividends and those without bond ratings -- that have been found to be "liquidity constrained" in previous studies. Our results cast doubt on the evidence for liquidity constraints from the many studies that have used Tobin's Q to control for the expected returns to investment.

Keywords: Investment, Tobin's Q, cash flow, liquidity constraints

Full paper (326 KB PDF) | Full paper (761 KB Postscript)

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Last update: June 30, 1999