Shiller's Cape: Market Efficiency and Risk

31 Pages Posted: 4 Oct 2018

See all articles by Valentin Dimitrov

Valentin Dimitrov

Rutgers, The State University of New Jersey - Accounting & Information Systems

Prem C. Jain

Georgetown University - Department of Accounting and Business Law

Multiple version iconThere are 2 versions of this paper

Date Written: November 2018

Abstract

Robert Shiller shows that Cyclically Adjusted Price to Earnings Ratio (CAPE) is strongly associated with future long‐term stock returns. This is often interpreted as evidence of market inefficiency. We present two findings contrary to such an interpretation. First, if markets are efficient, stock returns should be higher than the risk‐free rate. We find that even when CAPE is in its ninth decile, future 10‐year stock returns, on average, are higher than future returns on 10‐year U.S. Treasurys. Thus, the results are largely consistent with market efficiency. Second, consistent with a risk–return tradeoff, we find that CAPE is negatively associated with future stock market volatility.

Keywords: CAPE, market efficiency, stock returns, risk, market timing, market volatility

JEL Classification: G11, G12, G14, G40

Suggested Citation

Dimitrov, Valentin and Jain, Prem C., Shiller's Cape: Market Efficiency and Risk (November 2018). Financial Review, Vol. 53, Issue 4, pp. 741-771, 2018. Available at SSRN: https://ssrn.com/abstract=3260113 or http://dx.doi.org/10.1111/fire.12167

Valentin Dimitrov (Contact Author)

Rutgers, The State University of New Jersey - Accounting & Information Systems ( email )

1 Washington Park
Newark, NJ 07102
United States

Prem C. Jain

Georgetown University - Department of Accounting and Business Law ( email )

McDonough School of Business
Washington, DC 20057
United States
202-687-2260 (Phone)

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