Do Stock Price Bubbles Affect the Predictability of Stock Returns Through Earnings? Evidence From the 1990s S&P Bubble Period

Abstract

Asset price bubble means that the market value diverges from fundamental value and stock market price diverged significantly from the fundamental during the speculative period of the late 1990s. The majority of studies establishing strong evidence of the predictability of stock returns use data from before or up to the early 1990s. I hypothesized that bubbles will affect predictability of stock returns through earnings. The methodology presented by Phillips et al. (2011) is not only an ex ante econometric methodology but also one of the first attempts to date the origin and conclusion of a bubble period. This study clearly identifies the beginning and ending of the 1990s SP however, their 1990s sample periods were not consistent and they did not indicate the beginning and ending of the 1990s stock bubble period. I present evidence that stock price bubbles affect the predictability of stock returns through earnings, and that this predictability only exists in the periods in which no bubbles are present, the prebubble and post-bubble periods. The results are helpful for investors seeking to identify stock bubble periods, realizing the influence and consequence of stock bubbles, and performing their assets allocations.