How bad news can be good news

This is from an old MR post, summarizing Bernanke’s contributions to economics:

1. The theory of irreversible investment, circa 1983.
Before Bernanke, Dixit, and Pindyck, models often assumed that
investments could be reversed or "taken back."  Bernanke outlined how
the irreversibility of investment might matter.  Often individuals will
choose to wait and sample more information, rather than make an
immediate decision.  Small changes in information could lead to big
fluctuations in investment.  Large changes in interest rates might have
little effect.  Bad news can hurt you more than good news helps you.  This was Bernanke’s first major contribution to economics [and I believe part of his doctoral dissertation].

In this model it is also the case that bad news can cause equity prices to rise.  If the bad news resolves outstanding uncertainty, people may be willing to go ahead and invest, rather than continue to play wait and see.  One way to think about it is that the news could always have been even worse, so bad news can in effect be good news.  Another way to think about it is even truly bad news gets the waiting over with and spurs investors to cross a "do something" threshold.  Now I’m not saying that is what happened today, I’m just saying that maybe this thought crossed Bernanke’s mind…

Addendum: Elsewhere in the wonderful world of finance, here is why Bear Stearns is selling for more than $2 a share…


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