Does Speculation in Financial Markets Have Real Effects?

This paper examines how speculation in financial markets can affect real investments and asset prices with asymmetric adjustment costs. Investors with recursive preferences have heterogeneous beliefs about real productivity and some extraneous risk and trade them in financial markets. Speculation in financial markets, even on extraneous risk uncorrelated with productivity, can significantly affect real investments and asset prices. Speculation can either decrease or increase real investment and asset prices depending on whether investors EIS is less or greater than 1. With the EIS above 1, speculation can generate various boom-and-bust patterns such as what happened in the recent US housing markets