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 shifts in demand. Ship prices are far too volatile given the mean reversion in earnings. We show that high current ship earnings are associated with high secondhand ship prices and heightened industry investment in fleet capacity, but forecast low future returns. We propose and estimate a behavioral model that can account for the evidence. In our model, firms over-extrapolate exogenous demand shocks and partially neglect the endogenous investment responses of their competitors. Formal estimation of the model confirms that both types of expectational errors are needed to account for our findings.