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The neoclassical investment model with capital adjustment costs is a workhorse in the investment literature and has been used to explain many perceived anomalies in the cross section of stock returns. However, the model in its standard form is unable to explain the magnitudes of the significant run-up and subsequent fall in market values of equity during the late 1990s and early 2000s. This leaves two possibilities: either the neoclassical framework cannot account for observed stock price behavior during this period and we need to appeal instead to investor irrationality or time-varying uncertainty or the standard neoclassical model needs to be patched up so that it can account for observed stock price behavior during this period.
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