Stock Returns and Record-Breaking Skyscrapers

A new academic paper by Gunter Löffler of University of Ulm:

This papers shows that construction starts of record-breaking skyscrapers predict subsequent US stock returns. In the three to five years after the construction of a record-breaking new skyscraper began, per annum stock market returns are around 10 percentage points lower than in other years. The predictive ability is significant and relatively stable. It exceeds that of alternatives such as the prevailing historical mean, predictions based on dividend ratios, and recently suggested combination forecasts. The findings are robust against a wide range of specifications. Further analyses show that tower building also predicts international stock market returns. One explanation for these patterns is that tower building is indicative of over-optimism. Widespread over-optimism could lead not only to tower-building, but also to overvalued stock markets. The rational asset pricing explanation is that in periods of low risk aversion, financing of large-scale projects such as record-breaking towers is easier, and expected returns are lower. The explanations are difficult to separate empirically. There is no significant influence of financing conditions or sentiment on tower building. However, unlike in other models studied in the literature, imposing a non-negativity constraint on return forecasts does not increase predictive accuracy. This provides indirect evidence that the predictive content of tower building is at least partly related to overvaluation.

The idea is that the plans to build a monster new building are correlated with the mindset of a market bubble. The Woolworth Building opened in 1913 right as everything was falling apart. The Empire State Building was built during the depths of the Great Depression. The Petronas Towers in Kuala Lumpur were built just in time for the East Asian meltdown.

(HT: CXO Advisory)

Posted by on May 26th, 2011 at 10:05 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.