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Analyzing Stock Market Bubbles of the 1929 Great Depression

Explore the debate over the stock market bubble in the 1929 Great Depression through the lens of various hypotheses. Investigate factors like stock-market comovements, Tobin's q, and machinery orders as leading indicators of investment. Gain insights into the U.S. and German markets of the 1920s, examining how tangible and intangible capital valuations affect market perceptions. Delve into whether the stock market was overvalued or undervalued during this critical period and how financial markets aligned with real investment plans.

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Analyzing Stock Market Bubbles of the 1929 Great Depression

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  1. EH447, 08/09, Week 4-1 Great Depressions in Economic History A Bubble in the 1929 Stock Market? Albrecht Ritschl

  2. Bubble hypothesis • Frenetic stock market activity (Galbraith, 1958, many others) • Index increased faster than dividends (Rapoport/White, 1991)

  3. No-bubble hypothesis • Fisher (1929) • McGrattan and Prescott (2004): • Price/earnings ratios not out of ordinary • Capital taxes far lower than today • Market capitalisation 1.66 x GNP • Tangible capital 1.26 x GNP  30% less? • Intangible capital 0.87 x GNP  12% more

  4. An intermediate position Examine comovement between • stock market and • Leading indicator of investment

  5. Speculative bubble? The U.S. stock market 1920-35

  6. Tobin’s q q = =

  7. Tobin’s investment hypothesis • Machinery orders an indicator of I • Deflated version of Dow Jones an indicator of q

  8. Observations on Stock Market • Strong comovement in stock prices and orders of machinery • Orders of machinery a leading indicator of investment • Stock prices reflect (anticipated) investment / Tobin’s q holds • Peaks in early 1929 and Sept 1929

  9. Recession in Germany in 1927

  10. Observations on German stock market in 1920s • Comovement between machine orders and stock market, just like in U.S. BUT • Comovement is only between stock market and DOMESTIC orders • INTERNATIONAL orders peak in late 1929, in line with U.S. market • NO STOCK MKT CRASH IN 1929

  11. Speculative bubble? Maybe... • Market 30% overvalued if account for tangible capital only BUT • Market undervalued if include intangible capital • Financial market in sync with planned real investment

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