Project on Behavioral Finance and Financial Stability

Abstract

We evaluate Eugene Fama’s claim that stock prices do not exhibit price bubbles. Based on US industry returns 1926-2014 and international sector returns 1985-2014, we present four findings: (1) Fama is correct in that a sharp price increase of an industry portfolio does not, on average, predict unusually low returns going forward; (2) such sharp price increases predict a substantially heightened probability of a crash; (3) attributes of the price run-up, including volatility, turnover, issuance, and the price path of the run-up can all help forecast an eventual crash and future returns; and (4) some of these characteristics can help investors earn superior returns by timing the bubble. Results hold similarly in US and international samples. * We thank Randy Cohen, Josh Coval, Harry DeAngelo, Eugene Fama, Niels Gormsen, Sam Hanson, Owen Lamont, Juhani Linnainmaa, Yueran Ma, Lubos Pastor, Jeremy Stein, Adi Sunderam, Tuomo Vuolteenaho, and seminar participants at the University of Chicago, the University of Southern California, and the Federal Reserve Bank of Boston for their helpful suggestions. We are especially grateful to Niels Gormsen for extensive advice on Compustat Xpressfeed and independent replication of the results.