A Tale of Two Indexes: Predicting Equity Market Downturns in China

Abstract

Predicting stock market crashes is a focus of interest for both researchers and practitioners. Several prediction models have been developed, mostly for use on mature financial markets. In this paper, we investigate whether traditional crash predictors, the price-to-earnings ratio, the Cyclically Adjusted Price-to-Earnings ratio and the Bond-Stock Earnings Yield Differential model, predicts crashes for the Shanghai Stock Exchange Composite Index and the Shenzhen Stock Exchange Composite Index.

On the predictive power of CAPE or Shiller’s PE ratio: the case of the Greek stock market

“…In conclusion, the FTSE/ASE Large CAPE ratio and its variation the CAPE 5, which use five-year real earnings, are efficient estimators of future returns. Our findings are in line with Lleo & Ziemba ( 2019 ) and Angelini et al, ( 2012 ). In addition, our empirical findings are compatible with the findings of Dimitrov & Jain ( 2018 ) and Rangvid ( 2017 ).…”

“…Lleo and Ziemba ( 2019 ) showed that both the P/E and the CAPE performed much better than the BSEYD (Bond—Stock Earnings Differential) on the Shanghai Stock Exchange, while all three ratios performed very well on the Shenzhen Stock Exchange. Kim and Byun ( 2018 ) showed that the CAPE exhibits a predictive power over the performance of the Equally Weighted (EW) and the Value Weighted (VW) CRSP Indices– predicting the performance of the EW Index better, even for future one-year returns.…”

“…For many decades, the CAPE ratio (Cyclically Adjusted Price to Earnings ratio) or Shiller’s P/E ratio has been used by academics, researchers, investing firms and others in an attempt to evaluate the US Stock Market, especially the S&P Index and many other stock markets globally. The supporters of the ratio believe that it can predict future returns (Angelini et al 2012 ; Lleo and Ziemba 2019 ; Dimitrov and Jain 2018 ; Rangvid 2017 ).…”