TOWER BUILDING AND STOCK MARKET RETURNS

• Date: 01 September 2013
• DOI: http://doi.org/10.1111/j.1475-6803.2013.12017.x
• Published date: 01 September 2013
• Author: Gunter Löffler

TOWER BUILDING AND STOCK MARKET RETURNS

Gunter Löffler

University of Ulm

Abstract

Construction starts of skyscrapers predict subsequent U.S. stock returns. The predictive

ability exceeds that of alternatives such as the prevailing historical mean, predictions

based on dividend ratios, and recently suggested combination forecasts. One explanation

for these patterns is that tower building is indicative of overoptimism; alternatively, tower

building could help identify periods of low risk premia. I present indirect evidence that is

consistent with both explanations.

JEL Classification: G12, G14

I. Introduction

Ever since the story of the tower of Babel was recorded, the construction of large towers

has been associated with human hubris. From a finance theory perspective, towers are

large‐scale projects with uncertain future cash flows and large funding requirements.

These observations suggest two reasons why tower building might predict low future

stock market returns. Either it indicates periods in which overoptimism has led to

overvalued stock markets, or it helps identify times of low risk premia. (With low risk

premia, funding costs for large‐scale projects are lower, and future stock market returns

are expected to be relatively low as well.) An example that illustrates both interpretations

is the Chicago Spire, which had a planned height of 609 meters.

1

Construction of the

Chicago Spire began in June 2007, a time in which (1) risk premia—as exemplified by low

credit spreads—were low, and (2) valuation levels appear to have been relatively high.

Though the Chicago Spire stands out because of its planned height, it is representative of

the many high‐rise buildings planned that year. The number of towers taller than 100

meters that were started to be built in 2007 was more than twice the annual average of such

construction starts over the 20 years from 1987 to 2006.

2

In this article I therefore examine whether tower building is associated with lower

subsequent stock market returns. Building activity is measured through construction starts

of towers that exceed a trailing mean tower height. In the United States the predictive

power of this measure compares favorably to the predictive power of the dividend price

I am very grateful for comments received from Mark Freeman (the referee) and the editors as well as from Erik

Theissen and conference and seminar participants in Hamburg (German Finance Association), Hannover (Leibniz

University), and Rome (IFABS).

1

Construction of the building was halted in 2008.

2

Data are from Emporis, which is described in Section II.

The Journal of Financial Research Vol. XXXVI, No. 3 Pages 413–434 Fall 2013

413

© 2013 The Southern Finance Association and the Southwestern Finance Association

ratio, a variable that has been studied extensively in the literature (e.g., Welch and

Goyal 2008), as well as to recently suggested combination forecasts (Rapach, Strauss, and

Zhou 2010; Ferreira and Santa‐Clara 2011). Further analysis shows that international

tower building activity predicts a world ex U.S. stock market index.

The two possible explanations for the predictive content of tower building are

difficult to separate empirically. Indirect evidence is consistent with both explanations.

With rational asset pricing, forcing return forecasts to be nonnegative should increase

predictive accuracy,but the effects of such a constraint are mixed. Furthermore, both credit

market conditions and sentiment variables explain construction starts of large towers.

The perception that tower building can be linked to economic as well as stock

market performance is frequently voiced in the media.

3

Often, news articles cite the

research report of Lawrence (1999) and follow‐up reports (e.g., Lawrence et al. 2012).

The only associated academic paper I found is Thornton (2005), who discusses the

relation among tower building, business cycles, and economic crises but does not conduct

a statistical analysis. Barr (2010) empirically examines the determinants of skyscraper

height and concludes that status plays a role, leading to heights that exceed the profit‐

maximizing height.

There is a large body of literature on predicting stock markets with dividend ratios

and other variables. Classical references are Campbell and Shiller (1988) and Fama and

French (1988). Recent contributions include Goyal and Welch (2003), Malkiel (2004),

Fisher and Statman (2006), Boudoukh, Richardson, and Whitelaw (2008), Campbell and

Thompson (2008), Cochrane (2008), Welch and Goyal (2008), Rapach, Strauss, and

Zhou (2010), and Ferreira and Santa‐Clara (2011).

Whether stock market returns can be predicted is still controversial. Although the

evidence for in‐sample predictability appears strong, out‐of‐sample evidence is much

weaker. A possible reason for this wedge is structural breaks in fundamentals

(Lettau, Ludvigson, and Wachter 2008; Freeman 2011).

II. Data and Methodology

Data on towers are obtained from the research database of Emporis, a private information

provider focusing on building‐related information.

4

The database also contains

information on planned projects and construction status. I include buildings that were

started to be built but were never finished, thereby avoiding a possible selection bias that

might arise if only finished buildings were studied. The measure of height used is the

elevation from the base of building to its highest architectural element.

5

I select buildings

3

Examples include a 2005 article in Fortune (http://money.cnn.com/magazines/fortune/fortune_archive/2005/

09/05/8271392/index.htm) and a 2009 article in The Telegraph (http://www.telegraph.co.uk/news/worldnews/

middleeast/dubai/6934603/Burj‐Dubai‐The‐new‐pinnacle‐of‐vanity.html).

4

The quality of the database was confirmed through cross‐checks with Condit (1964), Landau and Condit

(1996), as well as official websites of existing buildings.

5

“Architectural Elements Include Everything Which Is Integral to the Design, Including Sculptures, Spires,

Screens, Parapets, and Decorative Features”(http://standards.emporis.com).

414 The Journal of Financial Research