How Do Financial Markets React to Long Term Development of Industries?

Abstract

We develop quantitative methodologies to classify industries by their development phase and apply this to analyze whether stock markets over- or underreact to industries shifting to another phase of development. We find little evidence for such market inefficiencies. On the contrary, a substantial portion of the (negative) excess returns for growing (declining) industries are earned in the run-up to the phase shift. These results suggest that stock markets reflect the information with regards to industrial development in stock market prices in the run-up to an industry entering a new phase. Consequently, bubbles at the industry level may be more of an exception than a rule and more difficult to identify ex-ante than sometimes thought.

Keywords: Industrial Development, Asset Pricing, Market Efficiency, Product Life Cycle, Overreaction, Underreaction, Growth Industries, Declining Industries

JEL Classification: G14, L16