Waves in Ship Prices and Investment
We study the returns to owning dry bulk cargo ships. Ship earnings exhibit a high degree of mean reversion, driven by industry participants' competitive investment responses to increases in demand. This mean reversion is not fully reflected in ship prices. We show that high current ship earnings are associated with high secondhand ship prices and heightened industry investment, but forecast low future returns. We suggest and estimate a behavioral model that can account for the evidence. In our model, individual firms overestimate their ability to respond to common shocks and underestimate the ability of the competition, leading to excessive industry investment during booms and low subsequent returns on capital. Our model nests both rational expectations at one extreme and Kaldor's (1938) cobweb theory at the other, in which producers naively set current production quantities based on lagged prices. Formal estimation of our model suggests significant competition neglect in the shipping industry.