This paper introduces a new approach to understanding investment. The distinctive feature of our approach is that shocks to the economic fundamentals have both persistent and transitory components, and that firms must disentangle the persistent from the transitory shocks. The model generates...

Dramatic fluctuations in the stock market raise questions about whether actual prices correspond to fundamentals. Even if there are "bubbles", they may not distort real behaviour if managers base investment decisions on fundamentals. Using a new specification testing strategy based on combining...