DP14468 The Big Bang: Stock Market Capitalization in the Long Run

Author(s): Dmitry Kuvshinov, Kaspar Zimmermann
Publication Date: March 2020
Keyword(s): equity valuations, return predictability, risk premiums, stock market capitalization, wealth-to-income ratios
JEL(s): E44, G10, N20, O16
Programme Areas: Financial Economics, Economic History, International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14468

This paper studies long-run trends in stock market capitalization and their drivers. New annual data for 17 advanced economies reveal a striking time series pattern: the ratio of stock market capitalization to GDP was roughly constant between 1870 and 1980, tripled with a historically unprecedented "big bang" in the 1980s and 1990s, and remains high to this day. We use data on equity returns, yields and cashflows to explore the underlying forces behind this structural shift. We show that the big bang is driven by two factors: a secular decline in the equity discount rate from 1980 onwards, and an upward shift in cashflows paid by listed firms. Equity issuance and new listings make next to no contribution to the structural increase in market cap. We also show that high market capitalization forecasts low equity returns, low dividend growth and a high risk of a stock market crash. This suggests that the currently high valuations and capitalization are a sign of high, rather than low risk in equity markets.