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A simple model of market valuation and trend reversion for U.S. equities: 100 Years of bubbles, non-bubbles, and inverse-bubbles

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  • Godek, Paul E.

Abstract

Appraising the current valuation of equity markets is a popular pastime for academics, investors, and pundits alike. Here I consider a measure of valuation based on a century-long trend of U.S. equity returns and the tendency of returns to revert (eventually) to that trend. The approach here is to incorporate a simple trend into an Ornstein–Uhlenbeck process. The empirical results offer some support for the theoretical description, though not to an extent that would cause harm to the concept of efficient markets. The reconciliation of trend reversion with market efficiency lies in the weakness of the trend’s “gravitational pull.” The results do, however, provide an operational measure for describing markets as over- or under-valued, which indicates that “bubbles” and “inverse bubbles” are both common.

Suggested Citation

  • Godek, Paul E., 2015. "A simple model of market valuation and trend reversion for U.S. equities: 100 Years of bubbles, non-bubbles, and inverse-bubbles," Finance Research Letters, Elsevier, vol. 13(C), pages 29-35.
    • Handle: RePEc:eee:finlet:v:13:y:2015:i:c:p:29-35
    DOI: 10.1016/j.frl.2015.03.006
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    References listed on IDEAS

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    Cited by:

    1. Amairi, Haifa & Zantour, Ahlem & Saadi, Samir, 2021. "Information dissemination and price discovery," Finance Research Letters, Elsevier, vol. 38(C).

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    More about this item

    Keywords

    Trend reversion; Ornstein–Uhlenbeck process; Bubbles and inverse bubbles; Efficient markets;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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