ECB Economists Warn of AI-Driven Stock Market Correction

Five economists at the European Central Bank (ECB) have published an analysis warning that stock market valuations may be due for a correction. The researchers, Malin Andersson, Johannes Breckenfelder, Stefano Corradin, Kalin Nikolov, and Maria Antonietta Viola, argue that US valuations are near their historical peak on the CAPE ratio, which compares share prices to inflation-adjusted earnings over the past decade.

The economists point out that even if current prices are rational, a correction is still possible due to the uncertainty surrounding new technologies like AI. According to their research, when a technology is first adopted by a few firms, failure is diversifiable, but as adoption spreads, the same uncertainty becomes economy-wide and investors demand a higher risk premium.

The researchers also note that overconfident investors may bid beyond fundamentals, leading to a market crash once their confidence diminishes. They warn that the exact moment of such a correction cannot be predicted in advance.

The analysis concludes that the potential for a correction is not just an equity market issue, but also a matter of financial stability for the euro area, particularly given the €440 billion exposure to US technology equities held by euro-area households.