Discussion paper
DP15546 How Financial Markets Create Superstars
High valuations reflect good growth prospects but can also improve these prospects by attracting key stakeholders, such as employees, business partners, or investors. We show that this feedback channel allows speculators without positive information about a firm to profit from inflating its stock price, thereby helping the firm to "fake it till it makes it." Reversing such feedback effects is hard even when traders have negative information. Likely targets are firms in "normal" (neither hot nor cold) markets, compensating stakeholders with performance pay or equity. Investors, such as VCs, can profit from inflating firms' valuations also in private markets.
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