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In the first chapter I investigate whether firms ' physical investments react to the specu-lative over-pricing of their securities. I introduce investment considerations in an infinite horizon continuous time model with short sale constraints and heterogeneous beliefs along the lines of Scheinkman and Xiong (2003) and obtain closed form solutions for all quan-tities involved. I show that market based q and investment are increased, even though such investment is not warranted on the basis of long run value maximization. I use a simple episode to test the hypothesis that investment reacts to over-pricing. With pub-licly available data on short sales during the 1920's, I examine both the price reaction and the investment behavior of a number of companies that were introduced into the "loan crowd " during the first half of 1926. In line with Jones and Lamont (2002), I interpret this as evidence of overpricing due to speculation. I find that investment by these companies follows both the increase and the decline in "q " before and after the introduction, suggesting that companies in this sample reacted to security over-pricing. In the next chapter of the thesis (co-authored with E. Farhi) we study optimal consump