Investment and share prices: Fundamental versus speculative components

This paper uses quarterly U.S. data from 1953(6) to 2000(6) to investigate the effects of share-price changes on investment. We focus on the distinction between speculative and fundamental components of share-price movements and we contribute to the literature by evaluating four alternative methods of decomposing share-price movements into these two components. The four methods are: (1) a decomposition based on regressing share returns on a set of variables designed to capture fundamentals; (2) the use of the price-earnings ratio; (3) the use of the dividend yield and (4) a structural vector-autoregressive model based on the dividend-discount equation. We find that, no matter what the method of decomposition is, shocks to both fundamental and speculative components have positive effects on investment and that, in contrast to the earlier literature, the effect of the speculative shock is at least as large as that of a shock to fundamentals. © 2004 Elsevier Inc. All rights reserved