American Journal of Economics 2014, 4(2A): 7-26 DOI: 10.5923/s.economics.201401.02 The Stock Market Boom and Crash of 1926-1933: An Applied Time Series Investigation Rattaphon Wuthisatian 1 , Dimitra Papadovasilaki 1 , Bhraman Gulati 2 , Federico Guerrero 1,* 1 Economics Department, University of Nevada, Reno, 89557, U.S. 2 State Demographer’s Office, Reno, Nevada, 89557, U.S. Abstract We study the price dynamics of 24 publicly traded companies in the New York Stock Exchange (NYSE) during the years 1926-1933 using data from the Wharton Research Data Service (WRDS) database. We find evidence against the hypothesis of random walks in stock prices. There was a bubble during the years 1927-29, which begins in the fall of 1927. Companies introducing new technologies, such as Radio Corporation of America (RCA), had their price peak first, and led the boom. Companies in traditional sectors had their peaks last, and were followers. In addition, there is significant price undershooting in the aftermath of the crash, in contrast to the typical experimental bubble a la Vernon Smith. Keywords Bubbles, Random Walks, Great Crash, Great Depression, 1929 Stock Market Crash 1. Introduction & Motivation The stock market crash of 1929 was so swift and the economic and social consequences of its aftermath so severe that memories from that period of time have, to a significant degree, been passed down to subsequent generations. The episode remains a hallmark of American economic turmoil (Klein, 2001). Historical studies have extensively covered the events before and after the crash and documented the consequences of it (e. g. Helder, 1974). In spite of extensive study, some key issues concerning the Great Crash remain contested. Among them, one is of central importance for our paper: Did a bubble cause the stock market crash of 1929? The answer leads to related and more general questions at the heart of financial economics, namely: are markets inherently unstable and cause bubbles that may result in economic disasters like the Great Depression when they unwind, or do stocks follow the Efficient Market Hypothesis with stock prices accurately representing all public information on the stocks’ relevant underlying fundamentals? Historical accounts of the Great Crash of 1929 (Galbraith, 1961; Wigmore, 1985; Rappoport and White, 1993, 1994; Klein, 2003; Ahamed, 2009; Kindleberger and Aliber, 2011, among others) tend to describe the years preceding the Great Crash as a bull market. Stock prices went up because further price increases were anticipated and investors were in search of those perceived capital gains (more or less * Corresponding author: guerrero@unr.edu (Federico Guerrero) Published online at http://journal.sapub.org/economics Copyright © 2014 Scientific & Academic Publishing. All Rights Reserved along the theoretical lines of Allen and Gorton, 1993, and the momentum strategies empirically tested by Chan et al., 1996), thus providing an unambiguously affirmative answer to the question posed above about the existence of a bull market in the years before the 1929 Crash. The reasons behind the Crash are not so clear-cut in the specialized financial economics literature. Santoni (1987) examined the percent changes in the Dow Jones Industrial Index (DJIA) around the time of the so-called ‘Coolidge bull market’ (1928-1929) and found no evidence of a speculative bubble. Similarly, Diba and Grossman (1987) found that stock prices and dividend payments were non- stationary in their levels but stationary in their first differences during the years of the Great Crash. The finding is an indication of the presence of random walks and thus negates the possibility of a bubble. In spite of a few papers presenting contrarian evidence (De Long and Shleifer, 1991, for instance), the consensus in the financial economic literature during the 1990s showed there was no clear evidence for bubbles at all, not only in the case of the market implosion of 1929, but for any episode (see the discussion in Rappoport and White, 1993, or refer to Fama, 1995a, Donaldson and Kamstra, 1996, among others, for additional examples). Even in the 2000s, a period marking the ascent of behavioral financial economics, no shortage of papers showing general skepticism toward bubbles in general (Meltzer, 2003, for instance), denying the existence of a bubble during the years of the so-called Great Crash (McGrattan and Prescott, 2000, 2001, 2003, and 2004, for example), or reaffirming the general empirical validity of the efficient markets hypothesis/no bubbles view of the world (Rubinstein, 2001, Malkiel, 2003; Yen and Lee, 2008) occurred. What accounts for these ambiguous results between the