Real Anomalies: Are Financial Markets a Sideshow?

Abstract

We examine the importance of asset pricing anomalies on the real economy. In order to assess distortions quantitatively, we estimate the joint dynamic distribution of firm characteristics that have been linked to anomalies, and other firm variables, such as investment, capital, and value added. Based on a model that matches these joint dynamics, we then evaluate the counterfactual dynamic distribution of these quantities absent financial market imperfections and find that they can cause significant deviations. Financial market anomalies can thus cause material real inefficiencies. This implies that financial intermediaries that reduce and/or eliminate such market imperfections can provide large value added to the economy. We show that mispricing is particularly destructive for high Tobin’s q firms. Further, the persistence and the amount of mispriced capital are a major determinant of the real economic consequences. Our flexible framework can be extended to evaluate the potential real effects associated with the ever-growing set of financial market imperfections.