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How Did It Happen?

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  • Brennan, Michael J
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    Abstract

    Between January 1980 and August 2000 American stock prices as measured by the S&P500 index rose by 1239%; over the same period the dividends on the shares underlying the index rose by only 188%, while the earnings rose by 254%. Between August 2000 and February 2003 the price index fell by 44% and, at the time of writing, some three and a half years later, the index is still some 25% below its August 2000 level, despite the fact that long term interest rates have fallen by around 100 basis points, and the fall is much greater if measured in terms of foreign currency such as the Euro. As Figure 1 shows, American stock price behavior at the turn of the millennium had all the characteristics of a classic bubble;2 prices climbed much faster than dividends or earnings, particularly starting from the beginning of 1995. What caused this?

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    Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number qt1047x6kv.

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    Date of creation: 01 Feb 2004
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    Handle: RePEc:cdl:anderf:qt1047x6kv

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    1. Brennan, Michael J. & Xia, Yihong, 2004. "International Capital Markets and Foreign Exchange Risk," University of California at Los Angeles, Anderson Graduate School of Management, Anderson Graduate School of Management, UCLA qt53z0s29k, Anderson Graduate School of Management, UCLA.
    2. Louis K. C. Chan & Jason Karceski & Josef Lakonishok, 2003. "The Level and Persistence of Growth Rates," Journal of Finance, American Finance Association, American Finance Association, vol. 58(2), pages 643-684, 04.
    3. Welch, Ivo, 2000. "Views of Financial Economists on the Equity Premium and on Professional Controversies," The Journal of Business, University of Chicago Press, vol. 73(4), pages 501-37, October.
    4. James Claus, 2001. "Equity Premia as Low as Three Percent? Evidence from Analysts' Earnings Forecasts for Domestic and International Stock Markets," Journal of Finance, American Finance Association, American Finance Association, vol. 56(5), pages 1629-1666, October.
    5. Eugene Fama & F. & Kenneth R. French, . "The Equity Premium."," CRSP working papers 522, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    6. John H. Cochrane, 1997. "Where is the market going? Uncertain facts and novel theories," Economic Perspectives, Federal Reserve Bank of Chicago, issue Nov, pages 3-37.
    7. Krigman, Laurie & Shaw, Wayne H. & Womack, Kent L., 2001. "Why do firms switch underwriters?," Journal of Financial Economics, Elsevier, Elsevier, vol. 60(2-3), pages 245-284, May.
    8. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
    9. Barberis, Nicholas & Thaler, Richard, 2003. "A survey of behavioral finance," Handbook of the Economics of Finance, Elsevier, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 18, pages 1053-1128 Elsevier.
    10. John H. Cochrane, 1999. "New Facts in Finance," NBER Working Papers 7169, National Bureau of Economic Research, Inc.
    11. Michaely, Roni & Womack, Kent L, 1999. "Conflict of Interest and the Credibility of Underwriter Analyst Recommendations," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 653-86.
    12. Summers, Lawrence H, 1986. " Does the Stock Market Rationally Reflect Fundamental Values?," Journal of Finance, American Finance Association, American Finance Association, vol. 41(3), pages 591-601, July.
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    Cited by:
    1. Robin Greenwood & Stefan Nagel, 2008. "Inexperienced Investors and Bubbles," NBER Working Papers 14111, National Bureau of Economic Research, Inc.
    2. Brennan, Michael J & Li, Feifei & Torous, Walt, 2005. "Dollar Cost Averaging," University of California at Los Angeles, Anderson Graduate School of Management, Anderson Graduate School of Management, UCLA qt53p0r65q, Anderson Graduate School of Management, UCLA.
    3. Charles Goodhart & Miguel A. Segoviano, 2004. "Basel and procyclicality: a comparison of the standardised and IRB approaches to an improved credit risk method," LSE Research Online Documents on Economics 24821, London School of Economics and Political Science, LSE Library.
    4. Kaizoji, Taisei (kaizoji@icu.ac.jp), 2010. "A behavioral model of bubbles and crashes," MPRA Paper 35655, University Library of Munich, Germany.
    5. Timothy Shields, 2008. "Analysts, Incentives, and Exaggeration," CIRANO Working Papers 2008s-11, CIRANO.
    6. Joseph Tao-yi Wang & Michael Spezio & Colin F. Camerer, 2010. "Pinocchio's Pupil: Using Eyetracking and Pupil Dilation to Understand Truth Telling and Deception in Sender-Receiver Games," American Economic Review, American Economic Association, vol. 100(3), pages 984-1007, June.
    7. Charles Goodhart & Boris Hofmann & Miguel Segoviano, 2004. "Bank Regulation and Macroeconomic Fluctuations," Oxford Review of Economic Policy, Oxford University Press, vol. 20(4), pages 591-615, Winter.
    8. Michael J. Seiler & David M. Harrison, 2011. "Perceived Versus Actual Susceptibility to Normative Influence in the Presence of Defaulting Landlords," Review of Behavioral Finance, Emerald Group Publishing, vol. 3(2), pages 55-77, November.
    9. Joseph Tao-yi Wang & Michael Spezio & Colin F. Camerer, 2006. "Pinocchio's Pupil: Using Eyetracking and Pupil Dilation to Understand Truth-telling and Deception in Games," Levine's Bibliography 321307000000000042, UCLA Department of Economics.
    10. Fernandez, Pablo & Aguirreamalloa, Javier & Liechtenstein, Heinrich, 2009. "The equity premium puzzle: High required equity premium, undervaluation and self fulfilling prophecy," IESE Research Papers D/821, IESE Business School.

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