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

Ian Martin and Can Gao

No 13454, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We define a sentiment indicator that exploits two contrasting views of return predictability, and study its properties. The indicator, which is based on option prices, valuation ratios and interest rates, was unusually high during the late 1990s, reflecting dividend growth expectations that in our view were unreasonably optimistic. We interpret it as helping to reveal irrational beliefs about fundamentals. We show that our measure is a leading indicator of detrended volume, and of various other measures associated with financial fragility. We also make two methodological contributions. First, we derive a new valuation-ratio decomposition that is related to the Campbell and Shiller (1988) loglinearization, but which resembles the traditional Gordon growth model more closely and has certain other advantages for our purposes. Second, we introduce a volatility index that provides a lower bound on the market's expected log return.

Keywords: Volatility; Valuation ratios; Bubbles; Sentiment; Option prices (search for similar items in EconPapers)
JEL-codes: G10 G12 G14 (search for similar items in EconPapers)
Date: 2019-01
New Economics Papers: this item is included in nep-cfn and nep-fmk
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Related works:
Journal Article: 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 (2021)
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