Beyond Random Assignment: Credible Inference and Extrapolation in Dynamic Economies |
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| Authors: | CHRISTOPHER A. HENNESSY ILYA A. STREBULAEV |
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| Affiliation: | 1. Christopher Hennessy is with London Business School, CEPR, and ECGI. Ilya A. Strebulaev is with Stanford Graduate School of Business and NBER. We thank Michael Roberts and Philip Bond (the Editors) and two anonymous referees for valuable input. We also thank Manuel Adelino, Antoinette Schoar, and Luke Taylor (discussants), as well as seminar participants at Stanford, Wharton, LBS, Duke, Boston University, LSE, UNC, UBC, Maryland, NC State, Imperial College, Simon Fraser, Koc, INSEAD, VGSF, SFI, SFS Cavalcade, the Causal Inference in Finance and Economics Conference, and the Stanford Conference on Causality in the Social Sciences. Disclosures: Hennessy received funding from the European Research Council related to this project. Strebulaev received no funding related to this project. We have read The Journal of Finance's disclosure policy and have no conflicts of interest to 2. disclose. |
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| 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 formulas are presented. |
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