We use a simple model to outline the conditions under which corporate investment will be sensitive to non-fundamental movements in stock prices. The key cross-sectional prediction of the model is that stock prices will have a stronger impact on the investment of firms that are “equity...

We build a model that helps explain why increases in liquidity-such as lower bid-ask spreads, a lower price impact of trade, or higher turnoverpredict lower subsequent returns in both firm-level and aggregate data. The model features a class of irrational investors, who underreact to the...