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Feedback Effects and Asset Prices




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    • Ozdenoren is with the Department of Economics, University of Michigan, and Yuan is with the Finance Department, Stephen M. Ross School of Business, University of Michigan. We thank the Editor, Cam Harvey, an anonymous associate editor, an anonymous referee, Marios Angeletos, Bob Barsky, Bernard Dumas, Itay Goldstein, David Hirshleifer, Arvind Krishnamurthy, Stephen Morris, Alessandro Pavan, Avanidhar Subrahmanyam, Jacob Sagi, Hyun Song Shin, and seminar participants at Cowles Foundation Workshop on Coordination Games at Yale University, the 2006 North American Summer Meeting of the Econometric Society, Michigan State University, and University of Michigan for their many insightful comments.


Feedback effects from asset prices to firm cash flows have been empirically documented. This finding raises a question for asset pricing: How are asset prices determined if price affects fundamental value, which in turn affects price? In this environment, by buying assets that others are buying, investors ensure high future cash flows for the firm and subsequent high returns for themselves. Hence, investors have an incentive to coordinate, which may generate self-fulfilling beliefs and multiple equilibria. Using insights from global games, we pin down investors' beliefs, analyze equilibrium prices, and show that strong feedback leads to higher excess volatility.