Market fundamentals versus rational bubbles in stock prices: a Bayesian perspective
AbstractUsing Bayesian Markov chain Monte Carlo methods, we decompose the log price-dividend ratio into a market fundamentals component and a bubble component. The market fundamentals component depends on expectations of future dividend growth and required returns, while the bubble component is assumed to follow a Markov switching model that allows for the possibility of exploding and collapsing regimes. If prior beliefs allow for the possibility of persistent shocks to dividend growth and|or required returns, the posterior distribution suggests the bubble component contributes virtually nothing to the stock price movements over our sample. On the other hand, if one's priors rule out the possibility of persistent shocks to dividend growth and required returns, the bubble component can have a much larger role to play in stock price movements. However, the regime switching behavior of the bubble bears little resemblance to infrequent switching from an exploding bubble regime to a collapsing or dormant bubble regime. Copyright © 2008 John Wiley & Sons, Ltd.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.
Volume (Year): 24 (2009)
Issue (Month): 1 ()
Contact details of provider:
Web page: http://www.interscience.wiley.com/jpages/0883-7252/
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Robert B. Barsky & J. Bradford De Long, 1992.
"Why Does the Stock Market Fluctuate?,"
NBER Working Papers
3995, National Bureau of Economic Research, Inc.
- Flood, Robert P & Garber, Peter M, 1980. "Market Fundamentals versus Price-Level Bubbles: The First Tests," Journal of Political Economy, University of Chicago Press, vol. 88(4), pages 745-70, August.
- Wu, Yangru, 1997. "Rational Bubbles in the Stock Market: Accounting for the U.S. Stock-Price Volatility," Economic Inquiry, Western Economic Association International, vol. 35(2), pages 309-19, April.
- van Norden, Simon & Schaller, Huntley, 1993. "The Predictability of Stock Market Regime: Evidence from the Toronto Stock Exchange," The Review of Economics and Statistics, MIT Press, vol. 75(3), pages 505-10, August.
- Simon van Norden, 1995.
"Regime Switching as a Test for Exchange Rate Bubbles,"
9502001, EconWPA, revised 09 Aug 1995.
- van Norden, Simon, 1996. "Regime Switching as a Test for Exchange Rate Bubbles," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(3), pages 219-51, May-June.
- Crowder, William J & Wohar, Mark E, 1998. "Stock Price Effects of Permanent and Transitory Shocks," Economic Inquiry, Western Economic Association International, vol. 36(4), pages 540-52, October.
- Chris Brooks & Apostolos Katsaris, 2005. "A Three-Regime Model of Speculative Behaviour: Modelling the Evolution of the S&P 500 Composite Index," Economic Journal, Royal Economic Society, vol. 115(505), pages 767-797, 07.
- Refet S. Gürkaynak, 2005.
"Econometric tests of asset price bubbles: taking stock,"
Finance and Economics Discussion Series
2005-04, Board of Governors of the Federal Reserve System (U.S.).
- Refet Gurkaynak, 2005. "Econometric Tests of Asset Price Bubbles: Taking Stock," Finance 0504008, EconWPA.
- J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, .
"Noise Trader Risk in Financial Markets,"
J. Bradford De Long's Working Papers
_124, University of California at Berkeley, Economics Department.
- Koustas, Zisimos & Serletis, Apostolos, 2005. "Rational bubbles or persistent deviations from market fundamentals?," Journal of Banking & Finance, Elsevier, vol. 29(10), pages 2523-2539, October.
- Cunado, J. & Gil-Alana, L.A. & de Gracia, F. Perez, 2005. "A test for rational bubbles in the NASDAQ stock index: A fractionally integrated approach," Journal of Banking & Finance, Elsevier, vol. 29(10), pages 2633-2654, October.
- Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
- Nathan S. Balke & Mark E. Wohar, 2006. "What Drives Stock Prices? Identifying the Determinants of Stock Price Movements," Southern Economic Journal, Southern Economic Association, vol. 73(1), pages 55â78, July.
- Evans, George W, 1991. "Pitfalls in Testing for Explosive Bubbles in Asset Prices," American Economic Review, American Economic Association, vol. 81(4), pages 922-30, September.
- Kenneth A. Froot & Maurice Obstfeld, 1992.
"Intrinsic Bubbles: The Case of Stock Prices,"
NBER Working Papers
3091, National Bureau of Economic Research, Inc.
- John H. Cochrane, 1992.
"Explaining the Variance of Price Dividend Ratios,"
NBER Working Papers
3157, National Bureau of Economic Research, Inc.
- Craine, Roger, 1993. "Rational bubbles : A test," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 829-846.
- Charemza, Wojciech W. & Deadman, Derek F., 1995. "Speculative bubbles with stochastic explosive roots: The failure of unit root testing," Journal of Empirical Finance, Elsevier, vol. 2(2), pages 153-163, June.
- John Y. Campbell & Robert J. Shiller, 1988.
"Cointegration and Tests of Present Value Models,"
NBER Working Papers
1885, National Bureau of Economic Research, Inc.
- Campbell, John & Shiller, Robert, 1987. "Cointegration and Tests of Present Value Models," Scholarly Articles 3122490, Harvard University Department of Economics.
- John Y. Campbell & Robert J. Shiller, 1986. "Cointegration and Tests of Present Value Models," Cowles Foundation Discussion Papers 785, Cowles Foundation for Research in Economics, Yale University.
- Van Norden, S. & Schaller, H., 1996.
"Speculative Behaviour, Regime-Switching and Stock Market Crashes,"
96-13, Bank of Canada.
- Simon van Norden & Huntley Schaller & ), 1995. "Speculative Behaviour, Regime-Switching, and Stock Market Crashes," Econometrics 9502003, EconWPA.
- Stephen F. Le Roy, 2004. "Rational Exuberance," Journal of Economic Literature, American Economic Association, vol. 42(3), pages 783-804, September.
- Hamilton, James D. & Whiteman, Charles H., 1985. "The observable implications of self-fulfilling expectations," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 353-373, November.
- Shiller, Robert J, 1981.
"Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?,"
American Economic Review,
American Economic Association, vol. 71(3), pages 421-36, June.
- Robert J. Shiller, 1980. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," NBER Working Papers 0456, National Bureau of Economic Research, Inc.
- Owen Lamont, 1998.
"Earnings and Expected Returns,"
Journal of Finance,
American Finance Association, vol. 53(5), pages 1563-1587, October.
- Diba, Behzad T & Grossman, Herschel I, 1988. "Explosive Rational Bubbles in Stock Prices?," American Economic Review, American Economic Association, vol. 78(3), pages 520-30, June.
- Caporale, Guglielmo Maria & Gil-Alana, Luis A., 2004. "Fractional cointegration and tests of present value models," Review of Financial Economics, Elsevier, vol. 13(3), pages 245-258.
- Shleifer, Andrei, 2000. "Inefficient Markets: An Introduction to Behavioral Finance," OUP Catalogue, Oxford University Press, number 9780198292272.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Wiley-Blackwell Digital Licensing) or (Christopher F. Baum).
If references are entirely missing, you can add them using this form.