Volatility, Valuation Ratios, and Bubbles: An Empirical Measure of Market Sentiment

Can Gao and Ian Martin

Journal of Finance, 2021, vol. 76, issue 6, 3211-3254

Abstract: We define a sentiment indicator based on option prices, valuation ratios, and interest rates. The indicator can be interpreted as a lower bound on the expected growth in fundamentals that a rational investor would have to perceive to be happy to hold the market. The bound was unusually high in the late 1990s, reflecting dividend growth expectations that in our view were unreasonably optimistic. Our approach exploits two key ingredients. First, we derive a new valuation ratio decomposition that is related to the Campbell–Shiller loglinearization but that resembles the Gordon growth model more closely and has certain other advantages. Second, we introduce a volatility index that provides a lower bound on the market's expected log return.

Date: 2021
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Citations: View citations in EconPapers (15)

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https://doi.org/10.1111/jofi.13068

Related works:
Working Paper: Volatility, valuation ratios, and bubbles: an empirical measure of market sentiment (2021)
Working Paper: Volatility, valuation ratios, and bubbles: An empirical measure of market sentiment (2021)
Working Paper: Volatility, Valuation Ratios, and Bubbles: An Empirical Measure of Market Sentiment (2019)
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