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Volatility, valuation ratios, and bubbles: an empirical measure of market sentiment

Gao, Can and Martin, Ian (2021) Volatility, valuation ratios, and bubbles: an empirical measure of market sentiment. Journal of Finance, 76 (6). 3211 - 3254. ISSN 0022-1082

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Identification Number: 10.1111/jofi.13068


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.

Item Type: Article
Official URL:
Additional Information: © 2021 The Authors
Divisions: Finance
Subjects: H Social Sciences > HG Finance
Date Deposited: 08 Feb 2021 12:48
Last Modified: 12 Jan 2022 16:03

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