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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. ISSN 0022-1082 (In Press)

[img] Text (Volatility, Valuation Ratios, and Bubbles: An Empirical Measure of Market Sentiment) - Accepted Version
Pending embargo until 1 January 2100.

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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 in order to be happy to hold the market. The lower bound was unusually high in the late 1990s, reflecting dividend growth expectations that in our view were unreasonably optimistic. We show that our measure is a leading indicator of detrended volume and of analysts’ long-term earnings growth expectations. Our approach depends on two key ingredients. First, we derive a new valuation-ratio decomposition that is related to the Campbell and Shiller (1988) loglinearization, but which 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 American Finance Association
Divisions: Finance
Subjects: H Social Sciences > HG Finance
Date Deposited: 08 Feb 2021 12:48
Last Modified: 19 Jul 2021 23:14

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