Beyond random assignment: credible inference and extrapolation in dynamic economies

Hennessy, C and Strebulaev, I A (2020) Beyond random assignment: credible inference and extrapolation in dynamic economies. Journal of Finance, 75 (2). pp. 825-866. ISSN 0022-1082

Abstract

We derive analytical relationships between shock responses and theory‐implied causal effects (comparative statics) in dynamic settings with linear profits and linear‐quadratic stock accumulation costs. For permanent profitability shocks, responses can have incorrect signs, undershoot, or overshoot depending on the size and sign of realized changes. For profitability shocks that are i.i.d., uniformly distributed, binary, or unanticipated and temporary, there is attenuation bias, which exceeds 50% under plausible parameterizations. We derive a novel sufficient condition for profitability shock responses to equal causal effects: martingale profitability. We establish a battery of sufficient conditions for correct sign estimation, including stochastic monotonicity. Simple extrapolation/error correction formulae are presented.

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Item Type: Article
Subject Areas: Finance
Additional Information:

This is the pre-peer-reviewed version of the following article: Beyond Random Assignment: Credible Inference and Extrapolation in Dynamic Economies, C A Hennessy and I A Strebulaev, The Journal of Finance, November 2019, which has been published in final form at https://doi.org/10.1111/jofi.12862 This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Use of Self-Archived Versions.

Funder Name: European Research Council
Subjects: P > Profit
E > Econometrics
Date Deposited: 27 Nov 2019 10:22
Last Modified: 10 Mar 2020 19:02
URI: https://lbsresearch.london.edu/id/eprint/1276
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